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Return Dynamics when Persistence is Unobservable

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  • Timothy C. Johnson

Abstract

This paper proposes a new theory of the sources of time‐varying second (and higher) moments in financial time series. The key idea is that fully rational agents must infer the stochastic degree of persistence of fundamental shocks. Endogenous changes in their uncertainty determine the evolution of conditional moments of returns. The model accounts for the principal observed features of volatility dynamics and implies some new ones. Most strikingly, it implies a relationship between ex post trends, or momentum, and changes in volatility.

Suggested Citation

  • Timothy C. Johnson, 2001. "Return Dynamics when Persistence is Unobservable," Mathematical Finance, Wiley Blackwell, vol. 11(4), pages 415-445, October.
    • Handle: RePEc:bla:mathfi:v:11:y:2001:i:4:p:415-445
    DOI: 10.1111/1467-9965.00123
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    Cited by:

    1. Tortorice, Daniel L., 2018. "Equity return predictability, time varying volatility and learning about the permanence of shocks," Journal of Economic Behavior & Organization, Elsevier, vol. 148(C), pages 315-343.
    2. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Clara Vega, 2003. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," American Economic Review, American Economic Association, vol. 93(1), pages 38-62, March.
    3. Timothy C. Johnson, 2002. "Rational Momentum Effects," Journal of Finance, American Finance Association, vol. 57(2), pages 585-608, April.
    4. Lubos Pastor & Pietro Veronesi, 2009. "Learning in Financial Markets," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 361-381, November.
    5. Xiaotong Wang & Heng-fu Zou, 2008. "Stock Return Dynamics under Earnings Management," CEMA Working Papers 331, China Economics and Management Academy, Central University of Finance and Economics.
    6. Nikitopoulos, Christina Sklibosios & Thomas, Alice Carole & Wang, Jianxin, 2023. "The economic impact of daily volatility persistence on energy markets," Journal of Commodity Markets, Elsevier, vol. 30(C).
    7. Wang, Jianxin, 2022. "Market distraction and near-zero daily volatility persistence," International Review of Financial Analysis, Elsevier, vol. 80(C).
    8. He, Xue-Zhong & Li, Kai & Santi, Caterina & Shi, Lei, 2022. "Social interaction, volatility clustering, and momentum," Journal of Economic Behavior & Organization, Elsevier, vol. 203(C), pages 125-149.
    9. David Feldman, 2007. "Incomplete information equilibria: Separation theorems and other myths," Annals of Operations Research, Springer, vol. 151(1), pages 119-149, April.
    10. Xiaotong Wang, 2005. "Stock Return Dynamics Under Earnings Management," Yale School of Management Working Papers amz2633, Yale School of Management, revised 01 Jul 2006.
    11. Xiaotong Wang, 2005. "Stock Return Dynamics Under Earnings Management," Yale School of Management Working Papers amz2633, Yale School of Management, revised 01 Jul 2006.

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