Extreme Asymmetric Volatility, Leverage, Feedback and Asset Prices
Posted: 6 Feb 2010 Last revised: 21 Jun 2015
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Extreme Asymmetric Volatility: Stress and Aggregate Asset Prices
Date Written: August 13, 2010
Abstract
Asymmetric volatility in equity markets has been widely documented in finance, where two competing explanations, as considered in Bekaert and Wu (2000), are the financial leverage and the volatility feedback hypothesis. We explicitly test for the role of both hypotheses in explaining extreme daily U.S. equity market movements during the period January 1990 to September 2008. To this aim, we examine asymmetric volatility based on a novel model of market returns, implied market volatility and volatility of volatility. We then test for extreme asymmetry and the distinct predictions of both hypotheses. Our results document significant extreme asymmetric volatility. This effect is contemporaneous, consistent with both hypotheses, and it is important for large market declines. We further derive aggregate asset pricing implications under extreme volatility feedback. Given our results, asymmetric volatility, which includes the effect of volatility feedback at extreme levels, is shown to play an important role in explaining substantial equity market declines.
Keywords: market volatility, asymmetric volatility, leverage effect, volatility feedback, VIX, market stress, systemic market risk
JEL Classification: C32, G1, G32
Suggested Citation: Suggested Citation
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