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Byline: Hazem Daouk, David Ng
Volatility asymmetry; Financial leverage; Leverage effect
Asymmetric volatility refers to the stylized fact that stock
volatility is negatively correlated to stock returns. Traditionally,
this phenomenon has been explained by the financial leverage effect.
This explanation has recently been challenged in favor of a risk premium
based explanation. We develop a new, unlevering approach to document how
well financial leverage, rather than size, beta, book-to-market, or
operating leverage, explains volatility asymmetry on a firm-by-firm
basis. Our results reveal that, at the firm level, financial leverage
explains much of the volatility asymmetry. This result is robust to
different unlevering methodologies, samples, and measurement intervals.
However, we find that financial leverage does not explain index-level
volatility asymmetry. We show that this difference between index-level
asymmetry and firm-level asymmetry is driven by the asymmetry of the
unlevered covariance component of index volatility.
Received 18 April 2009; Revised 16 July 2010; Accepted 9 May 2011
(footnote) [star] We thank Utpal Bhattacharya, Anchada Charoenrook,
Tim Crack, Robert Dittmar, Michael Gallmeyer, Robert Hodrick, Craig
Holden, Robert Jennings, Dan Jubinski, Sreenivas Kamma, Josef
Lakonishok, Charles Lee, Jun Pan, Lasse Pedersen, Richard Shockley,
Albert Wang, Xiaoyan Zhang, and Guofu Zhou, as well as seminar
participants at Amsterdam, Cornell, Cincinnati, HEC Paris, Illinois,
Maryland, Oklahoma, Queen's, Singapore Management, UC Riverside,
Washington, and York Universities, the American Finance Association
meeting, the Western Finance Association meeting, the University of
Chicago-CRSP forum and the Frank Batten Young Scholars Conference for
helpful discussions and comments. We thank Ajay Palvia and Jiyoun An for
excellent research assistance. Hazem Daouk acknowledges financial
support from the Peter J. and Stephanie J. Nolan Professorship of
Finance. Remaining errors are our own.