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Why Are Asset Returns More Volatile During Recessions? A Theoretical Explanation

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  • Monique Ebell

    (Universitat Pompeu Fabra)

Abstract

During recession, many macroeconomic variables display higher levels of volatility. We show how introducing an AR(1)-ARCH(1) driving pro- cess into the canonical Lucas consumption CAPM framework can account for the empirically observed greater volatilty of asset returns during re- cessions. In particular, agents' joint forecasting of levels and time-varying second moments transforms symmetric-volatility driving processes into asymmetric-volatility endogenous variables. Moreover, numerical exam- ples show that the model can indeed account for the degree of cyclical variation in both bond and equity returns in the U.S. data. Finally, we argue that the underlying mechanism is not speci.c to .nancial markets, and has the potential to explain cyclical variation in the volatilities of a wide variety of macroeconomic variables.

Suggested Citation

  • Monique Ebell, 2000. "Why Are Asset Returns More Volatile During Recessions? A Theoretical Explanation," Computing in Economics and Finance 2000 355, Society for Computational Economics.
    • Handle: RePEc:sce:scecf0:355
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    Cited by:

    1. Zeng, Songlin & Bec, Frédérique, 2015. "Do stock returns rebound after bear markets? An empirical analysis from five OECD countries," Journal of Empirical Finance, Elsevier, vol. 30(C), pages 50-61.
    2. Frédérique Bec & Annabelle de Gaye, 2019. "Le modèle autorégressif autorégressif à seuil avec effet rebond : Une application aux rendements boursiers français et américains ," Working Papers hal-02014663, HAL.
    3. Duncan, Roberto, 2016. "Does the US current account show a symmetric behavior over the business cycle?," International Review of Economics & Finance, Elsevier, vol. 41(C), pages 202-219.
    4. Hess, Martin K., 2003. "What drives Markov regime-switching behavior of stock markets? The Swiss case," International Review of Financial Analysis, Elsevier, vol. 12(5), pages 527-543.
    5. Van Nieuwerburgh, Stijn & Veldkamp, Laura, 2006. "Learning asymmetries in real business cycles," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 753-772, May.
    6. Martin Hess, 2006. "Timing and diversification: A state-dependent asset allocation approach," The European Journal of Finance, Taylor & Francis Journals, vol. 12(3), pages 189-204.

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