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Pricing Stock Market Volatility: Does it Matter whether the Volatility is Related to the Business Cycle?

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  • Yunmi Kim
  • Charles R. Nelson

Abstract

This article investigates the impact of business cycle-related market volatility on expected returns. We develop a model that enables us to decompose the market volatility into two components: business cycle-related volatility and unrelated volatility. Then, the risk–return relation is assessed based on these two components. Our empirical results demonstrate that business cycle-related market volatility is priced in the stock market, whereas the unrelated component is not. Furthermore, our procedure identifies a few periods of high volatility that are not related to recessions, including the 1987 crash and the 1998 Russian default.

Suggested Citation

  • Yunmi Kim & Charles R. Nelson, 2014. "Pricing Stock Market Volatility: Does it Matter whether the Volatility is Related to the Business Cycle?," Journal of Financial Econometrics, Oxford University Press, vol. 12(2), pages 307-328.
    • Handle: RePEc:oup:jfinec:v:12:y:2014:i:2:p:307-328.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbt014
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    Cited by:

    1. Stanislav Bozhkov & Habin Lee & Uthayasankar Sivarajah & Stella Despoudi & Monomita Nandy, 2020. "Idiosyncratic risk and the cross-section of stock returns: the role of mean-reverting idiosyncratic volatility," Annals of Operations Research, Springer, vol. 294(1), pages 419-452, November.
    2. Giovanna Bua & Carmine Trecroci, 2019. "International equity markets interdependence: bigger shocks or contagion in the 21st century?," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 155(1), pages 43-69, February.
    3. Chen, Na & Jin, Xiu, 2020. "Industry risk transmission channels and the spillover effects of specific determinants in China’s stock market: A spatial econometrics approach," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    4. Zhang, Wei & Zhou, Zhong-Qiang & Xiong, Xiong, 2019. "Behavioral heterogeneity and excess stock price volatility in China," Finance Research Letters, Elsevier, vol. 28(C), pages 348-354.
    5. Joëts, Marc, 2014. "Energy price transmissions during extreme movements," Economic Modelling, Elsevier, vol. 40(C), pages 392-399.
    6. Cho, Jaeho & Yoo, Byoung Hark, 2011. "The Korean stock market volatility during the currency crisis and the credit crisis," Japan and the World Economy, Elsevier, vol. 23(4), pages 246-252.
    7. Huang, Yu-Fan & Startz, Richard, 2020. "Improved recession dating using stock market volatility," International Journal of Forecasting, Elsevier, vol. 36(2), pages 507-514.
    8. Marc Joëts, 2012. "Energy price transmissions during extreme movements," Working Papers hal-04141047, HAL.
    9. repec:ipg:wpaper:28 is not listed on IDEAS
    10. repec:ipg:wpaper:2013-028 is not listed on IDEAS
    11. Kim Chang-Jin & Kim Yunmi, 2019. "A unified framework jointly explaining business conditions, stock returns, volatility and “volatility feedback news” effects," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 23(2), pages 1-14, April.

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