Economics Insights @ CBS

It appears that volatility in equity markets is asymmetric: returns and conditional volatility are negatively correlated. We provide a unified framework to simultaneously investigate asymmetric volatility at the firm and the market level and to examine two potential explanations of the asymmetry: leverage effects and volatility feedback. Our empirical application uses the market portfolio and portfolios with different leverage constructed from Nikkei 225 stocks. We reject the pure leverage model of Christie (1982) and find support for a volatility feedback story.

Previous theories of financial market rationing focussed on a single market, either the credit or the equity market. An interesting question is whether credit and equity rationing are mutually compatible, and how they interact. We consider a model with two-dimensional asymmetric information, where entrepreneurs have private information about both the expected returns and the risk of their projects. We show that credit and equity rationing may occur individually or simultaneously.

We propose a cross-sectional time-series model to assess the impact of market liberalizations in emerging equity markets on the cost of capital, volatility, beta, and correlation with world market returns. Liberalizations are defined by regulatory changes, the introduction of depositary receipts and country funds, and structural breaks in equity capital flows to the emerging markets. We control for other economic events that might confound the impact of foreign speculators on local equity markets.