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College of Management. Georgia Institute of Technology, Atlanta, G A 30332, U.S.A. SUMMARY In this paper issues of volatility persistence and the changing risk premium in the stock market are investigated using the GARCH estimation technique. We get a point estimate of the index of relative risk aversion of 4.5 and confirm the existence of changing equity premiums in the US during 1962-1985. The persistence of shocks to the stock return volatility is so high that the data cannot reject a non-stationary volatility process specification. The results of this paper are consistent with Malkiel and Pindyckâs hypothesis that i t is the unforseen rise in the investment uncertainty during 1974 that causes the market to plunge. 1. INTRODUCTION The temporal behaviour of the stock market volatility has received increasing interest recently. The upward trend in volatility during the past three decades has been contended by Malkiel (1979) and Pindyck (1984) to be the major reason for the decline in equity prices. Pindyck argues that âthe variance of the firmsâ real gross marginal return on capital has increased significantly since 1965, that this has increased the relative riskiness of investorsâ net real returns from holding stocks, and that this
Journal of Applied Econometrics – Wiley
Published: Oct 1, 1988
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