Economic Cycles and Stock Return Volatility: Evidence from the Past Two Decades

Abstract

We use EGARCH-M models to examine the co-cyclical nature of stock returns in relation to economic cycles, focusing on three key variables, namely stock return volatility, risk premium and information asymmetry. We incorporate a wider and systematic alley of major global economic events since 1990s to the end of 2011. The main objective is to provide a corroborative evidence of the cyclicality nature of stock return volatility in the global context, and to present a consolidated volatility alley in association with major economic events. The overall conclusion is that increases in stock returns during good economic conditions tend to be associated with increases in risk premium, but decreases in overall risk and the impact of bad news (information asymmetry), and increase or decrease in volatility persistent. It is the vice versa during bad times. This conclusion emphasizes findings from previous studies, while providing new intuitions for stimulating more debate on the nature of contradictions from previous studies. Also, our findings have significant implications for investors and decision-makers at corporate, national, and international levels.