Early News is Good News - Abstract

Early News is Good News: The Effects of Market
Opening on Market Volatility

Giampiero M. Gallo and Barbara Pacini
Dip. di Statistica "G. Parenti"
Università di Firenze


Pages 115-131

Abstract

In this paper, we examine the characteristics of market opening news and its impact on the estimated coefficients of the conditional volatility models of the GARCH class. We find that the differences between the opening price of one day and the closing price of the day before have different characteristics when considering various stock-market indices on which options are actively traded. The impact of a suitable positive-valued transformation of these differences has the effects of modifying the direct impact of daily innovations on volatility and reducing the estimated overall persistence of such innovations. The overall contribution of the variable is evaluated in an out-of-sample forecasting exercise, where we obtain significant improvements above the simple GARCH model.

Bibliography

  • Andersen, T. (1995). "Return volatility and trading volume: an information flow interpretation of stochastic volatility." Working Paper 170, National Bureau of Economic Research, Cambridge, MA.
  • Berlin, H. M. (1990). The Handbook of Financial Market Indexes, Averages, and Indicators . Homewood, IL: Dow Jones-Irwin.
  • Berry, T. D., and K. M. Howe (1994). "Public information arrival." The Journal of Finance , 4:1331-1346.
  • Bollerslev, T., R. F. Engle, and D. B. Nelson (1994). "ARCH models." In R. F. Engle and D. L. McFadden (eds.), Handbook of Econometrics , vol. 4. Amsterdam: North-Holland, ch. 49, pp. 2961-3038.
  • Campbell, J. Y., A. W. Lo, and A. C. MacKinlay (1997). The Econometrics of Financial Markets . Princeton, NJ: Princeton University Press.
  • Christoffersen, P. F., and F. Diebold (1996). "Optimal prediction under asymmetric loss." Unpublished Manuscript, Department of Economics, University of Pennsylvania.
  • Clark, P. (1973). "A subordinated stochastic process model with finite variance for speculative prices." Econometrica , 41:135-156.
  • Diebold, F., and R. S. Mariano (1995). "Comparing predictive accuracy." Journal of Business and Economic Statistics , 3:253-263.
  • Ding, Z., C. W. J. Granger, and R. F. Engle (1993). "A long memory property of stock market returns and a new model." Journal of Empirical Finance , 1:83-106.
  • Engle, R. F. (1982). "Autoregressive conditional heteroskedasticity with estimates of the variance of UK inflation." Econometrica , 55:987-1008.
  • Engle, R. F., and V. K. Ng (1993). "Measuring and testing the impact of news on volatility." Journal of Finance , 48:1749-1778.
  • Gallo, G. M., and B. Pacini (1997). "The effect of trading activity on market volatility." In Proceedings of the BNP--Imperial College Conference on Forecasting Financial Markets . London: Banque Nationale de Paris and Imperial College.
  • Granger, C. W. J., and M. H. Pesaran (1996). "A decision-theoretic approach to forecast evaluation." Unpublished Manuscript, Trinity College, Cambridge.
  • Hamilton, J. D., and R. Susmel (1994). "Autoregressive conditional heteroskedasticity and changes in regime." Journal of Econometrics , 64:307-333.
  • Kim, C. J. (1993). "Unobserved-component time series models with Markov-switching heteroskedasticity: Changes in regime and the link between inflation rates and inflation uncertainty." Journal of Business and Economic Statistics , 11:341-349.
  • Lamont, O., R. Lumsdaine, and C. M. Jones (1996). "Public information and the persistence of bond market volatility." Working Paper 5446, National Bureau of Economic Research, Cambridge, MA.
  • Lamoureux, C. G., and W. D. Lastrapes (1990a). "Heteroskedasticity in stock return data: Volume versus GARCH effects." The Journal of Finance , 45:221-229.
  • Lamoureux, C. G., and W. D. Lastrapes (1990b). "Persistence in variance, structural change, and the GARCH model." Journal of Business and Economic Statistics , 8:225-234.
  • Nelson, D. B. (1991). "Conditional heteroskedasticity in asset returns: A new approach." Econometrica , 59:347-370.
  • Silverman, B. W. (1986). Density Estimation for Statistics and Data Analysis . New York: Chapman and Hall.
  • Tauchen, G., and M. Pitts (1983). "The price variability-volume relationship on speculative markets." Econometrica , 51:485-505.
  • Weiss, A. A. (1985). "Stability of heteroskedastic process." Journal of Time Series Analysis , 4:303-310.