GARCH-M MODEL AND THE BEHAVIOR OF RISK-RETURN RELATIONSHIP IN INDONESIA STOCK MARKET

Abstract

This study examines the risk-return trade-off and volatility behaviour in Indonesia stock market. As the analytical tool this study uses GARCH-M model with symmetric GARCH(1,1).  To obtain more reliable results, this study takes daily and weekly stock index as well as 5 individual stock returns from January 2004 to November 2020 as a sample. This study also investigates the results with two alternative mean equations, simple regression and AR(1) model. The first finding of this study is that in Indonesia stock market both in stock index and in individual stocks, the volatilities of return are time varying. From investigating the risk-return relationship the results are mixed. This study finds that positive risk-return relationships in stock market index are observed both in daily and weekly data. A positive risk-return relationhip in stock market index is also found either in AR(1) model of mean equation or in simple regression model. The same results are observed in two stocks investigated. There is one stock where a positive risk return relationship is observed only in daily return data not in weekly return data. A negative risk-return relationships is observed in one stock and there is no evidence of risk-return trade-off in one stock. The conclusion is that a positive risk-return relationship as a postulated by investment theory only exists in stock index and does not exist in all stocks
  
 Key words : Indonesia stock market, Risk-return trade-off, GARCH-M, GARCH(1,1), Time-varying volatility.