Michal Dzielinski, Marc Oliver Rieger, and To ̃nn Talpsepp
ABSTRACT
Volatility is typically higher in down markets. Using an international comparison of
volatility asymmetry and an analysis of a complete set of stock market transactions, we
show that this effect, known as ‘‘leverage effect’’, is most likely driven by the over-
reaction of private investors to bad news. This result is supported by our observation
that an increase in attention to negative news (as measured by an increase in Google
searches for keywords related to the macroeconomy like ‘‘recession’’) can predict a
subsequent increase in volatility.
11.1 INTRODUCTION
When prices drop, volatility increases. This general observation was most noticeable
during the recent Credit Crisis, where—following stock market drops—volatility
reached record values. The effect has been most widely explained by changes in leverage
and the existence of time-varying risk premiums. It is therefore sometimes called the
‘‘leverage effect’’, but we will use the more neutral namevolatility asymmetry, since so
far no clearly recognized explanation exists.
In this chapter we investigate the potential relation between the occurrence of
volatility asymmetry, news, and private investors. In Section 11.2 we summarize the
results from a study comparing volatility asymmetry in 49 countries worldwide
(Talpsepp and Rieger, 2009). The study shows that volatility asymmetry is most pro-
nounced in highly developed markets and, in particular, in markets with high participa-
tion of private investors. Moreover, we find that markets with many financial analysts
actually show higher volatility after downturns. These results suggest that private
investors might react nervously to bad news. We show that times of high news con-
centration are typically times of many bad news, thus the overreaction of private
investors to bad news will likely lead to the observed asymmetry in volatility.
Further evidence for this relationship between news, private investors, and volatility
asymmetry is reported in Section 11.3.1, which discusses volatility of the S&P 500
increases after an increase in the number of Google searches for specific keywords
The Handbook of News Analytics in Finance Edited by L. Mitra and G. Mitra
#2011 John Wiley & Sons