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RISK PERCEPTION AND EQUITY RETURNS: EVIDENCE FROM THE SPX AND VIX

Authors

  • Jianhua Gang,

    Corresponding author
    1. China Financial Policy Research Center, School of Finance, Renmin University of China, China
    • Correspondence: Jianhua Gang, China Financial Policy Research Center, School of Finance, Renmin University of China, 59 Zhong Guan Cun Street, Beijing, 100872, P.R. China. Email: jhgang@ruc.edu.cn.

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  • Xiang Li

    1. Department of Finance, School of Economics, Shanghai University, China
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  • Supported by the Fundamental Research Funds for the Central Universities, and the Research Funds of Renmin University of China (No.11XNK003).

ABSTRACT

We use the semi-nonparametric (SNP) model to study the relationship between the innovation of the Volatility Index (VIX) and the expected S&P 500 Index (SPX) returns. We estimate the one-step-ahead contemporaneous relation subject to leverage GARCH effect. Results agree with a body of newly established literature arguing non-linearity, and asymmetries. In addition, the risk-return behaviour depends on the signs as well as magnitudes of the perceived risk. We conclude that influence of fear or exuberance on the conditional market return is non-monotonic and hump-shaped. Very deep fear does not necessarily mean huge losses, instead, the loss may not be as bad as fears of normal levels. Results pass the robustness tests.

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