Threshold Asymmetries in Equity Return Distributions: Statistical Tests and Investment Implications

Abstract

In this paper we investigate asymmetries in time-varying means, volatilities, correlations, and betas of equity returns in a multivariate threshold framework. We consider alternative specifications in which the threshold variable is based on well established equity pricing factors and predictors. We find strong threshold effects with respect to market excess return, value premium, and term spread. Our results indicate that the threshold model based on the market excess return provides a flexible and computationally inexpensive specification for modeling asymmetries. We test significance of specific forms of asymmetries using subsampling methods. We compare performance of the proposed threshold model with a variety of alternatives in an out-of-sample setup and find that the threshold model performs remarkably well, especially for investors with relatively high risk aversion.