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Leverage effect in financial markets: the retarded volatility model
J P Bouchaud1, A Matacz, M Potters
1Service de Physique de l'Etat Condensé, Centre d'études de Saclay, Orme des Merisiers, 91191 Gif-sur-Yvette Cedex, France.
Physical Review Letters
|December 12, 2001
Summary
The leverage effect, a negative link between past stock returns and future volatility, is stronger in stock indices than individual stocks. A new model explains this phenomenon for individual stocks, while indices require an amplification effect.
Area of Science:
- Quantitative finance
- Financial econometrics
- Market microstructure
Background:
- The leverage effect describes the negative correlation between past returns and future volatility.
- This phenomenon is observed in financial markets but requires quantitative investigation.
Purpose of the Study:
- To quantitatively investigate the leverage effect in individual stocks and stock indices.
- To develop models explaining the observed leverage effect for different market participants.
Main Methods:
- Quantitative analysis of historical stock market data.
- Development and application of a novel stochastic process model.
- Comparative analysis of individual stocks versus stock indices.
Main Results:
- A moderate, decaying leverage effect was found for individual stocks over 50 days.
- A stronger, faster-decaying leverage effect was observed for stock indices.
- A universal value for individual stocks was rationalized by a 'retarded' stochastic model.
- Stock indices necessitate an amplification phenomenon to explain the effect's amplitude.
Conclusions:
- The leverage effect differs significantly between individual stocks and stock indices.
- A new stochastic model provides a framework for understanding the leverage effect in individual stocks.
- Stock indices exhibit unique amplification dynamics influencing the leverage effect.