Viewing the economy as production system that generates a future stream of real production together with a portfolio of real options, I would say the the valuation of the stock market increases with volatility.

Thanks Dr. Platinga for your viewpoint, in fact, I agree to your above statement that volatility do help increase valuation of stock markets. But similarly, it has also been observed that markets fell or rather crashed following volatility. Volatility as a spread of uncertainty, wherein investors starts to assume (or dispel) risk, apprehension so it might be a two sided game; markets either go up or go down following volatile times. Are there any historical studies which indicate specifically that volatility, in the majority of times, provide forward momentum (bull phase) to the markets? Any case citing contrariwise?

Regards,

Sidharta

Dear Sidharta

There is a very, very old paper on this topic -- if I understand you correctly.

http://schwert.ssb.rochester.edu/fss.htm

However, this paper was written in 1987 and there is conflicting evidence in many other studies, I guess. And as times are changing and we write the year 2012, in which over 60% of stock trading is triggered by algorithmic trading, the evidence might have changed again. Financial markets have become so large that I doubt that they mainly reflect the real economy anymore. Other forces are at work as well.

Cheers,

Markus

Well, thanks Markus for your link citing the work, in fact as i find it, the authors are old, great experts of the market, and there are perhaps few things we still need to learn from their experiences. A very, very old paper may turn out be some treasure-hunt indeed, for some golden rules I would suggest hidden somewhere within...

Many thanks again for the very good link!!!

Sincerely,

Sidharta

An old thread that I have just seen. My take is that very high volatility signals an appreciation in equities ahead because it results from a large decline in equity prices in the face of great uncertainty. When I looked at the issue in August 2011 following the US debt downgrade, I found that there had been four episodes were the VIX (S&P 500 implied vol) exceeded 40. They were the stock market crash of 1987, Long-Term Capital in 1998, 9/11 in 2001 and Lehman in 2008. In the first three cases the S&P posted double-digit returns over the next six months. In the case of Lehman, it took a little longer (the market bottom was March 2009). Following the debt downgrade, the VIX again surged above 40 and the S&P 500 fell to 1099. It now stands above 1500. My belief is that Frank Knight's view that the source of profit is bearing uncertainty (uninsurable risks) applies to the equity market. Interestingly, low vol does not necessarily signal a period of poor stock market returns ahead. There is no correlation between vol and year-ahead returns on the S&P. It seems it is just the surges in vol associated with plunging markets that signal opportunities.

https://www.researchgate.net/publication/301578726_Stock_Market_and_Macroeconomic_Behavior_Evidence_from_Karachi_Stock_Exchange_KSE

Article Stock Market and Macroeconomic Behavior: Evidence from Karac...

Hi,

You may benefit from this paper:

C Chen J Kim, L Yao, "Earnings smoothing: Does it exacerbate or constrain stock price crash rish?", Journal of Corporate Finance, 2017, 42, p 36 -54.

Best regards.

Hello

I just thought of sharing some of my experience in this regard. I tested the volatility using GARCH and eGARCH on CNX Nifty from 2000 to 2015. This was phased as per calendar year. I found that 2002-03 and 2005-06 were the two phases being the more volatile ones compared to the other phases. Interestingly both these two phases were followed by unprecedented bull rally in Nifty. So, volatility of a high range do indicate that an upswing is in the corner. However this study was only focused on Nifty.

Hope this helps.