On December 12, 2019, Fed in Print will introduce its new platform for discovering content. Please direct your questions to Anna Oates

Home About Latest Browse RSS Advanced Search

Federal Reserve Bank of Atlanta
FRB Atlanta Working Paper
Risk, Return, and Volatility Feedback: A Bayesian Nonparametric Analysis
Mark J. Jensen
John M. Maheu

The relationship between risk and return is one of the most studied topics in finance. The majority of the literature is based on a linear, parametric relationship between expected returns and conditional volatility. This paper models the contemporaneous relationship between market excess returns and contemporaneous log-realized variances nonparametrically with an infinite mixture representation of their joint distribution. The conditional distribution of excess returns given log-realized variance will also have an infinite mixture representation but with probabilities and arguments depending on the value of realized variance. Our nonparametric approach allows for deviation from Gaussianity by allowing for higher-order nonzero moments and a smooth nonlinear relationship between the conditional mean of excess returns and contemporaneous log-realized variance. We find strong robust evidence of volatility feedback in monthly data. Once volatility feedback is accounted for, there is an unambiguous positive relationship between expected excess returns and expected log-realized variance. This relationship is nonlinear. Volatility feedback impacts the whole distribution and not just the conditional mean.

Download Full text
Cite this item
Mark J. Jensen & John M. Maheu, Risk, Return, and Volatility Feedback: A Bayesian Nonparametric Analysis, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper 2014-6, 01 Jun 2014.
More from this series
JEL Classification:
Subject headings:
Keywords: Dirichlet process prior; slice sampling; dependent Bayesian nonparametrics
For corrections, contact Elaine Clokey ()
Fed-in-Print is the central catalog of publications within the Federal Reserve System. It is managed and hosted by the Economic Research Division, Federal Reserve Bank of St. Louis.

Privacy Legal