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ABSTRACT: We examine aggregate idiosyncratic volatility in 23 developed equity markets, measured using various methodologies, and we find no evidence of upward trends. Instead, idiosyncratic volatility appears to be well described by a stationary autoregressive process that occasionally switches into a higher-variance regime that has relatively short duration. We also document that idiosyncratic volatility is highly correlated across countries. Finally, we examine the determinants of the time-variation in idiosyncratic volatility. In most specifications, the bulk of idiosyncratic volatility can be explained by a growth opportunity proxy, total (US) market volatility, and in most but not all specifications, the variance premium, a business cycle sensitive risk indicator. Our results have important implications for studies of portfolio diversification, return volatility and contagion.
National Bureau of Economic Research, Inc, NBER Working Papers. 01/2010;
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ABSTRACT: We examine the pricing of aggregate volatility risk in the cross-section of stock returns. Consistent with theory, we find that stocks with high sensitivities to innovations in aggregate volatility have low average returns. Stocks with high idiosyncratic volatility relative to the Fama and French (1993, "Journal of Financial Economics" 25, 2349) model have abysmally low average returns. This phenomenon cannot be explained by exposure to aggregate volatility risk. Size, book-to-market, momentum, and liquidity effects cannot account for either the low average returns earned by stocks with high exposure to systematic volatility risk or for the low average returns of stocks with high idiosyncratic volatility. Copyright 2006 by The American Finance Association.
Journal of Finance. 02/2006; 61(1):259-299.
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ABSTRACT: Many have questioned the empirical relevance of the Calvo-Yun model. This paper adds a term structure to three widely studied macroeconomic models (Calvo-Yun, hybrid and Svensson). We back out from observations on the yield curve the underlying macroeconomic model that most closely matches the level, slope and curvature of the yield curve. With each model we trace the response of the yield curve to macroeconomic shocks. We assess the fit of each model against the observed behaviour of interest rates and find limited support for the Calvo-Yun model in terms of fit with the observed yield curve, we find some support for the hybrid model but the Svensson model performs best.
National Bureau of Economic Research, Inc, NBER Working Papers. 01/2000;
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ABSTRACT: We document extreme bias and dispersion in the small sample distributions of five standard regression tests of the expectations hypothesis of the term structure of interest rates. These biases derive from the extreme persistence in short interest rates. We derive approximate analytic expressions for these biases, and we characterize the small-sample distributions of these test statistics under a simple first-order autoregressive data generating process for the short rate. The biases are also present when the short rate is modeled with a more realistic regime-switching process. The differences between the small-sample distributions of test statistics and the asymptotic distributions partially reconcile the different inferences drawn when alternative tests are used to evaluate the expectations hypothesis. In general, the test statistics reject the expectations hypothesis more strongly and uniformly when they are evaluated using the small-sample distributions, as compared to the asymptotic distributions.
02/1996;
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ABSTRACT: Many have questioned the empirical relevance of the Calvo-Yun model. This paper adds a term structure to three widely studied macroeconomic models (Calvo-Yun, hybrid and Svensson). We back out from observations on the yield curve the underlying macroeconomic model that most closely matches the level, slope and curvature of the yield curve. With each model we trace the response of the yield curve to macroeconomic shocks. We assess the fit of each model against the observed behaviour of interest rates and find limited support for the Calvo-Yun model in terms of fit with the observed yield curve, we find some support for the hybrid model but the Svensson model performs best.
Federal Reserve Bank of Chicago, Working Paper Series, Issues in Financial Regulation. 01/1996;
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ABSTRACT: This paper first characterizes the predictable components in excess rates of returns on major equity and foreign-exchange markets using lagged excess returns, dividend yields, and forward premiums as instruments. Vector autoregressions demonstrate one-step-ahead predictability and facilitate calculations of implied long-horizon statistics, such as variance ratios. Estimation of latent variable models then subjects the vector autoregressions to constraints derived from dynamic asset pricing theories. Examination of volatility bounds on intertemporal marginal rates of substitution provides summary statistics that quantify the challenge facing dynamic asset pricing models. Copyright 1992 by American Finance Association.
Journal of Finance. 01/1992; 47(2):467-509.
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ABSTRACT: In an effort to explain simultaneously the excess return predictability observed in equity, bond and foreign exchange markets, we incorporate preferences exhibiting first-order risk aversion into a general equilibrium two-country monetary model. When we calibrate the model to US and Japanese data, we find that first-order risk aversion substantially increases excess return predictability. However, this increased predictability is insufficient to match the data. We conclude that the observed patterns of excess return predictability are unlikely to be explained purely by time-varying risk premiums generated by highly risk averse agents in a complete markets economy.
Journal of Monetary Economics.
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ABSTRACT: The hypothesis that the forward rate is an unbiased predictor of the future spot rate has been consistently rejected in recent empirical studies. This paper examines several sources of measurement error and misspecification that might induce biases in such studies. Although previous inferences are shown to be robust to a failure to construct true returns and to omitted variable bias arising from conditional heteroskedasticity in spot rates, we show that the parameters were not stable over the 1975–89 sample period. Estimation that allows for endogenous regime shifts in the parameters demonstrates that deviations from unbiasedness were more severe in the 1980s. (JEL F31).
Journal of International Money and Finance.
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ABSTRACT: We investigate whether term structure anomalies in U.S. data may be due to a generalized peso problem, in which a high-interest-rate regime occurred less frequently in the U.S. sample than was rationally anticipated. We formalize this idea by estimating a regime-switching model of short-term interest rates with data from seven countries. Under the small-sample distributions generated by the model, the expectations hypothesis is rejected. When we allow moderate time variation in term premiums, the term-premium dynamics interact with peso-problem effects to generate small-sample distributions more consistent with the data. Nonetheless, our model cannot fully account for U.S. term structure anomalies.
Journal of Monetary Economics.
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ABSTRACT: Stocks with recent past high idiosyncratic volatility have low future average returns around the world. Across 23 developed markets, the difference in average returns between the extreme quintile portfolios sorted on idiosyncratic volatility is -1.31% per month, after controlling for world market, size, and value factors. The effect is individually significant in each G7 country. In the United States, we rule out explanations based on trading frictions, information dissemination, and higher moments. There is strong covariation in the low returns to high-idiosyncratic-volatility stocks across countries, suggesting that broad, not easily diversifiable factors lie behind this phenomenon.
Journal of Financial Economics.
