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Robert F. Engle, Emil N. Siriwardane, Structural GARCH: The Volatility-Leverage Connection, The Review of Financial Studies, Volume 31, Issue 2, February 2018, Pages 449–492, https://doi.org/10.1093/rfs/hhx099
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Abstract
In the aftermath of the financial crisis, institutions have been asked to reduce leverage in order to reduce risk. To address the effectiveness of this measure, we build a model of equity volatility that accounts for leverage. Our approach blends Merton’s insights on capital structure with traditional time-series models of volatility. We estimate that precautionary capital needs for the entire financial sector reached $2 trillion during the crisis. We also investigate the long-standing observation that equity volatility asymmetrically responds to positive and negative news. Volatility asymmetry is mostly explained by exposure to the aggregate market, not a mechanical leverage effect.
Received March 27, 2015; editorial decision February 25, 2017 by Editor Andrew Karolyi.
