The mean/volatility asymmetry in Asian stock markets

Abstract

This study tests the asymmetric responses of mean reversion and volatility using the asymmetric nonlinear smooth transition generalized autoregressive conditional heteroskedasticity (ANST-GARCH) model. The asymmetric mean reversion and volatility reflect the fact that investors react more strongly to bad news than to good news. Since risk averse investors overweigh more severely the potentials of bad news after a heavy loss, this study applies daily stock index returns from Hong Kong, Japan, Malaysia, Singapore, South Korea, Taiwan and Thailand during 1994–2005 to test this hypothesis. The result shows that following the Asian financial crisis most markets displayed increased sensitivity to bad news, which confirms the hypothesis.

Acknowledgements

We would like to thank Dr Giorgio Valente (Co-editor) and the anonymous referee for their insightful comments. All remaining errors are the authors’ responsibility.

Notes

¹ Following Nelson (1991), this study clarified positive lagged return shocks as good news and negative lagged return shocks as bad news.

² De Bondt and Thaler (1985), who first examined the overreaction hypothesis in finance, hypothesized that a trading strategy based on buying recent losers and selling recent winners can achieve excess profits (contrarian profit) over both short- and long-term investment periods.

³ Volatility feedback is another explanation for asymmetric volatility. Pindyck (1984) and Campbell and Hentschel (1992) contend that if market risk premium is an increasing function of expected volatility, then increased volatility should cause a drop in stock price, contributing to asymmetric return variances.

⁴ For a risk aversion individual investor, Pratt (1964) indicates that if absolute risk aversion is decreasing in wealth, implying that risk premium and investor's wealth are in the opposite direction. This characteristic is termed as decreasing absolute risk aversion.

⁵ Otchere and Chan (2003) examined, but ultimately rejected, the hypothesis that overreaction to bad news increased during the post-crisis period in the Hong Kong market.

⁶ We would like to thank an anonymous referee for pointing this out.

⁷ For details see Nam et al . (2003).