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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Time-varying Volatility and the Power Law Distribution of Stock Returns
While many studies find that the tail distribution of high frequency stock returns follow a power law, there are only a few explanations for this finding. This study presents evidence that time-varying volatility can account for the power law property of high frequency stock returns. The power law coefficients obtained by estimating a conditional normal model with nonparametric volatility show a striking correspondence to the power law coefficients estimated from returns data for stocks in the Dow Jones index. A cross-sectional regression of the data coefficients on the model-implied coefficients yields a slope close to one, supportive of the hypothesis that the two sets of power law coefficients are identical. Further, for most of the stocks in the sample taken individually, the model-implied coefficient falls within the 95 percent confidence interval for the coefficient estimated from returns data.
Cite this item
Missaka Warusawitharana, Time-varying Volatility and the Power Law Distribution of Stock Returns, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2016-022, 18 Mar 2016.
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
- D30 - Microeconomics - - Distribution - - - General
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
Keywords: Tail distributions ; high frequency returns ; power laws ; time-varying volatility
This item with handle RePEc:fip:fedgfe:2016-22
is also listed on EconPapers
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