Raul Susmel

Autoregressive conditional heteroskedasticity and changes in regime

ARCH models often impute a lot of persistence to stock volatility and yet give relatively poor forecasts. One explanation is that extremely large shocks, such as the October 1987 crash, arise from quite different causes and have different consequences for subsequent volatility than do small shocks. We explore this possibility with U.S. weekly stock returns, allowing the parameters of an ARCH process to come from one of several different regimes, with transitions between regimes governed by an unobserved Markov chain. We estimate models with two to four regimes in which the latent innovations come from Gaussian and Student t distributions.

Volatility and Cross Correlation Across Major Stock Markets

Several papers have documented the fact that correlations across major stock markets are higher when markets are more volatile - this is done by comparing unconditional correlations over sub-periods or by using conditional correlations that are time varying. In this paper we examine the relation between correlation and variance in a conditional time and state varying framework. We use a switching ARCH (SWARCH) technique that does two things. One, it enables us to model variance as state varying. Two, a bivariate SWARCH model allows us to go from conditional variance to state varying covariances and correlations and hence test for differences in correlations across variance regimes. We find that the correlations between the U.S. and other world markets are on average 2 to 3.5 times higher when the U.S. market is in a high variance state as compared to a low variance regime. We also find that, compared to a GARCH framework, the portfolio choices resulting from our SWARCH model lead to higher Sharpe ratios.

Hourly volatility spillovers between international equity markets

Abstract This paper examines the timing of mean and volatility spillovers between New York and London equity markets. Using an ARCH model it is found that the evidence of volatility spillovers between these markets is minimal and have a duration which lasts only an hour or so. The most significant effects surround the movement of share prices around the New York opening, but these results are not strong. Several new ARCH models are estimated including an asymmetric or ‘leverage’ model and a non-linear model which allows big shocks to have a different impact from small shocks.

Common Volatility in International Equity Markets

In this article, we take advantage of the time-varying structure of stock-returns variances to investigate whether two international stock markets share the same volatility process. We use a test recently developed by Engle and Kozicki. This test is also used to assess the validity of a one-factor autoregressive conditional heteroscedasticity model. We find that some international stock markets have the same time-varying volatility.

Interest-Rate Volatility in Emerging Markets

We use high-frequency interest-rate data for a group of Latin American and Asian countries to analyze the behavior of volatility through time. We focus on volatility comovements across countries. Our analysis relies on univariate and bivariate switching volatility models. We compare the results from the switching models with those from rolling-standard-deviation models. We argue that the switching models are superior. Our results indicate that high-volatility episodes are, in general, short-lived, lasting from 2 to 7 weeks. We also find some evidence of interest-rate volatility comovements across countries.

Extreme observations and diversification in Latin American emerging equity markets

In this paper, we focus on the tails of the unconditional distribution of latin American emerging markets stock returns. We explore their implications for portfolio diversification according to the safety first principle, first proposed by Roy (1952). We find that the Latin American emerging markets have significantly fatter tails than industrial markets, especially, the lower tail of the distribution. We consider the implication of the safety first principle for a U.S. investor who creates a diversified portfolio using Latin America stock markets. We find that a U.S. investor gains by adding Latin American equity markets to her purely domestic portfolio. For different parameter specifications, we find a more realistic asset allocation than the one suggested by the literature based on the traditional meanvariance framework.

Switching Volatility in Private International Equity Markets

This paper analyzes the behavior of time-varying volatility when structural changes are allowed in international stock markets. A model developed by Hamilton and Susmel (1994), the switching autoregressive conditional heteroskedastic (SWARCH) model, which is a more general specification than the popular ARCH model, is used. An exponential SWARCH model is fitted to eight series of weekly returns from international stock markets. Evidence is found for switching volatility for the US, Canada, the UK, and Japan. Under the SWARCH model, it is found that ARCH and asymmetric effects are reduced when a switching regime structure is allowed. The switching model is used to date volatility states in international stock markets. These states are compared and it is concluded that domestic volatility states tend to be independent of foreign volatility states, with the exception of Japan and the UK, and the US and Canada. For these two pairs of series, evidence is found for common volatility states. Copyright @ 2000 by John Wiley & Sons, Ltd. All rights reserved.

Returns on ADRs and Arbitrage in Emerging Markets

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Volatility, storage and convenience: Evidence from natural gas markets

This papers tests a theoretical implication of the theory of storage. We examine the U.S. natural gas market over a period of extensive change in market structure brought about by regulatory action. We motivate and test the hypothesis that the change in market structure increased spot price volatility. The theory of storage implies that a shift to a higher volatility state leads to an increase in convenience yield and therefore, an increase in the use of storage. Using a switching ARCH model, which allows the ARCH parameters to be state dependent, we find evidence that volatility of natural gas prices increased with the change in market structure. We also find that the switch to a higher volatility state is associated with investment in additional storage capacity.

Variances and covariances of international stock returns: the international capital asset pricing model revisited

Abstract In this paper we examine a conditional version of the international capital asset pricing model allowing for a time and state varying factor of proportionality or beta. Betas are allowed to change with an unobserved state variable. Return variances differ across the different states so that betas differ on account of differences in variance regimes of the return series. This method allows us to accommodate a non-linear relation between returns and variances. For six markets, we find that the world beta is a non-linear function of domestic volatility. In the Pacific and North American markets we find strong evidence for a time and state varying beta coefficient. We find that for the European markets, with the exception of Switzerland, the world beta is not related to the state of the domestic markets volatility.