Abstract
This study analyses risk-return trade-off and behaviour of various volatility dynamics including: volatility, its persistence, mean reversion and speed of mean reversion along with asymmetry and leverage effect on the Pakistani stock market by employing aggregate (aggregate market level) and disaggregate (sectoral level) monthly data for the period from 1998 to 2012. Three generalised autoregressive conditional heteroscedasticity models were applied: GARCH (1,1) for various volatility dynamics; EGARCH for asymmetric and leverage effect and GARCH-M for pricing of risk. The outcomes of the study are as follows: first, the volatility shocks are quite persistent but with varying degrees across the sectors. Both the ARCH effect (short-term effect) and GARCH effect (long-term effect) play their role in generating conditional future stock returns volatility. Further, overall the volatility process is mean reverting; however, the speed of mean reversion varies across the sectors. Secondly, the current study finds little evidence of asymmetry and leverage effect at both aggregate and disaggregates data. Thirdly, the pricing of risk (positive risk premium) is also evident, particularly at the disaggregate data in the Pakistani stock market. Finally, this research study sets the implications for both the policy makers and investors.
Highlights
The landmark contribution of Markowitz (1952) stems from the idea that investors usually claim higher returns on market portfolio than the investment in risk-free securities
It is incredible that this one GARCH (1, 1) model can be sufficiently applied in any financial time series in order to comprehend the volatility dynamics
The results show that there is evidence of the asymmetry and leverage effect for the stock returns of the Oil & Gas, Chemical, Electricity, Auto & Parts, Gas & Water, Pharma & Bio, Personal Goods, Life Insurance, Financial Services, Fixed Line Telecom, General Industrial, Fixed Line Telecom, Electronics & Electricity and Industrial Metal and Mining sectors
Summary
The landmark contribution of Markowitz (1952) stems from the idea that investors usually claim higher returns on market portfolio than the investment in risk-free securities. The pioneer explanation of the leverage effect hinges on the study of Black (1976) and later on Christie (1982) They reported that negative news (price fall) increases the financial leverage thereby resulting in rise in stock returns volatility. It is established that the rise or fall in macroeconomic variables stems from a dissimilar effect on stock returns across the sectors resulting is different volatility dynamics (Elyasiani et al, 2011) It is widely agreed in the financial press that investors always expect higher returns for holding risky assets.
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