Risk, uncertainty and stock returns predictability – a case of emerging equity markets

Abstract

PurposeThis paper aims to investigate the predictability of stock returns under risk and uncertainty of a set of 11 emerging equity markets (EEMs) during the pre- and post-crash periods.Design/methodology/approachListed indices are considered to serve the proxy of stock markets with a structural break in data for the period: 2000-2014. As preliminary results highlight the significant autocorrelations in stock returns, Threshold-GARCH (1,1) model is used to estimate the conditional volatility, which is further decomposed into expected and unexpected volatility.FindingsResults highlight that the volatility has symmetric impact on stock returns during the pre-crash period and asymmetric impact during the post-crash period. While testing the relationship of stock returns, a significant positive (negative) relationship is found with expected volatility during the pre-crash (post-crash) periods. The stock returns are found positively related to unexpected volatility.Research limitations/implicationsBusiness, political and other market conditions of sample stock markets are fundamentally different. These economies were liberalized in different years, which may affect the degree of integration with international equity markets.Practical implicationsThe findings highlight that investors consider the impact of expected volatility in forecasting of stock returns during the growth period. They realize returns in commensurate to risk of their portfolios. However, they significantly reduce their investments in response to expected volatility during the recession period. The positive relationship between stock returns and unexpected volatility highlights the fact that investors realize extra returns for exposing their portfolios to unexpected volatility.Originality/valuePioneer efforts are made by using T-GARCH (1,1) procedure to analyse the problem. Given the emergence of emerging equity markets, new insight in dynamics of stock returns provide interesting findings for portfolio diversification under risk and uncertainty.