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Related Experiment Videos

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
PubMed
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.

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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:

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  • 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.