We use quantile regression to investigate the short-term return-volatility relation between stock index returns and changes in implied volatility index. Neither the leverage hypothesis nor the volatility feedback hypothesis effectively explains the asymmetric return-volatility relation. Instead, behavioral explanations, such as the affect and representativeness heuristics, are supported by our results, particularly in the short-term; the affect heuristic plays an important role. Moreover, in the context of an extreme volatility change distribution, the affect heuristic and time-pressure dominate. Thus, we observe strong negative and asymmetric relations between each volatility index and its corresponding stock market index. The asymmetry increases monotonically from the median quantile to the uppermost quantile (i.e., 95%); therefore, ordinary least squares (OLS) regression underestimates this relation at upper quantiles. Additionally, the VIX presents the highest asymmetric return-volatility relation, followed by the VSTOXX, VDAX, and VXN. Finally, the observed asymmetry is more pronounced with the new volatility index measure than with the old, at-the-money volatility index measure.

Read the full paper at: Quantile Regression Analysis of the Asymmetric Return-Volatility Relation

Source: Badshah, Ihsan, Quantile Regression Analysis of the Asymmetric Return-Volatility Relation (January 26, 2010). Forthcoming in the Journal of Futures Markets. Available at SSRN: http://ssrn.com/abstract=1543213 or http://dx.doi.org/10.2139/ssrn.1543213

Keywords: Asymmetric return-volatility relation, implied volatility, index options, quantile regression, volatility index