Relationship of Risk Premium with Expected Volatility and Unexpected Volatility in Developing and Developed Economies

Abstract

After application of ARIMA model to monthly risk premium and Threshold GARCH-In-Mean (TGARCH-M) models to daily risk premium of developed economies i.e. USA, UK, Germany, France and Canada and developing economies i.e. Pakistan, India, Malaysia and China over a period from January 2000 to December 2014, this study reported that in monthly data relationship between risk premium and expected volatility is negative in Pakistan: positive in Indonesia and Canada while insignificant in all other countries. The relationship between risk premium and unexpected volatility is negative in all the countries except Pakistan and China where it is insignificant while positive in USA. By the application of asymmetric volatility model on daily data for the same span, the relationship between risk premium and expected volatility is negative and significant in UK and France while this relationship is insignificant in all other countries. The study also indicates that the arrival of bad news has a greater impact on conditional volatility than the arrival of good news in all the economies whether developing or developed.