Information updating and the bounce-back effect of stock market returns

Abstract

Purpose – Bounce-back effect of stock market returns has been found empirically using different approaches. However, few paper explains the underlying mechanism. The paper aims to discuss these issues. Design/methodology/approach – This paper fills this gap and provides an explanation for bounce-back effect in stock market. Findings – This paper contributes to the literature in threefold. The authors contribute a formal economic model to rationalize the bounce-back effect of stock market returns. It is based on a model of stock return with volatility feedback under the assumption of Markov-Switching market volatility. Originality/value – The authors use the general Markov-Switching bounce-back model, developed by Bec et al. (2015), to provide empirical evidence for the existence of bounce-back effect in stock market. The empirical result shows “W” shape of bounce-back effect, which is exactly the same as predicted by the economic theoretical model. Finally, the authors propose an alternative approach to estimate the magnitude of volatility feedback and the marginal effect on the expected return of an anticipated high variance regime.