The Threshold Effect in Expected Volatility: A Model Based on Asymmetric Information
- 1 July 1997
- journal article
- Published by Oxford University Press (OUP) in The Review of Financial Studies
- Vol. 10 (3) , 837-869
- https://doi.org/10.1093/rfs/10.3.837
Abstract
This article develops theoretical insight into the threshold effect in expected volatility, which means that large shocks are less persistent in volatility than small shocks. The model uses the Kyle-Admati-Pfleiderer setup with liquidity traders, informed traders, and a market maker. Information is modeled as a GARCH process. It is shown that the GARCH process for information is transformed into a TARCH process (for “threshold GARCH”) for the market price changes. Working with information flows allows one to derive implications for trading volume and market liquidity which provide the basis for a more complete test of the model.Keywords
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