The Effect of Volatility Changes on the Level of Stock Prices and Subsequent Expected Returns

Authors

  • ROBERT A. HAUGEN,

  • ELI TALMOR,

  • WALTER N. TOROUS

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    • University of California, Irvine; Tel Aviv University and University of California, Irvine; and University of California, Los Angeles; respectively. We would like to thank Yakov Amihud and David Bates for insightful comments and Kwan Ho Kim, James Berens, and Stephanie Shaw for excellent research assistance.

ABSTRACT

This paper estimates volatility changes in daily returns to the Dow Jones Industrial Average over the sample period 1897 through 1988. This allows a direct investigation of the reaction of the level of stock prices and subsequent expected returns to these estimated changes in volatility. We provide empirical evidence consistent with relatively large and systematic revisions in stock prices and subsequent expected returns to volatility changes. However, there appears to be an asymmetry in the market's reaction to volatility increases as opposed to volatility decreases. A majority of our volatility changes cannot be associated with the release of significant economic information.

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