Realized Measures to Explain Volatility Changes over Time

Christos Floros,Konstantinos Gkillas,Athanasios Tsagkanos,Christoforos Konstantatos

doi:10.3390/jrfm13060125

Christos Floros, Konstantinos Gkillas + Show 2 more

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https://doi.org/10.3390/jrfm13060125

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Abstract

We studied (i) the volatility feedback effect, defined as the relationship between contemporaneous returns and the market-based volatility, and (ii) the leverage effect, defined as the relationship between lagged returns and the current market-based volatility. For our analysis, we used daily measures of volatility estimated from high frequency data to explain volatility changes over time for both the S&P500 and FTSE100 indices. The period of analysis spanned from January 2000 to June 2017 incorporating various market phases, such as booms and crashes. Based on the estimated regressions, we found evidence that the returns of S&P500 and FTSE100 indices were well explained by a specific group of realized measure estimators, and the returns negatively affected realized volatility. These results are highly recommended to financial analysts dealing with high frequency data and volatility modelling.

Highlights

Asset pricing in financial literature is predicated on the importance of volatility in asset returns
We investigated the impact of the realized measures on returns and vice versa, considering Standard & Poor’s 500 Index (S&P500) and Financial Times Stock Exchange 100 Index (FTSE100) indices for the period spans from January 2000 to June 2017
We considered 10 realized measures from the Oxford-Man Institute of Quantitative Finance database to examine two hypotheses associated with the financial modelling and decision-making: (i) the volatility feedback effect as the relationship between the contemporaneous returns and the market-based volatility and (ii) the leverage effect as the relationship between lagged returns and the current market-based volatility

Summary

Introduction

Asset pricing in financial literature is predicated on the importance of volatility in asset returns. Financial market volatility is a key factor ranging from investment decisions to derivatives pricing and financial market regulation (Poon and Granger 2003). Volatility is an unobservable variable and its effects on financial markets are hard to anticipate. This is one of the reasons that asset return volatilities (volatility) are of utmost importance to empirical finance. In other words, it remains the ingredient in assessing asset or portfolio risk, playing an important role in asset pricing models which heavily depend on underlying asset return dynamics. Asset management and asset pricing models require the proper volatility modeling of financial assets

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