Stock Return Volatility on Scandinavian Stock Markets and the Banking Industry

The expectations hypothesis of the term structure of interest rates is tested using monthly Eurodollar deposit rates for maturities 1, 3 and 6 months covering the period 1983:1–1996:6. Whereas classical regression-based tests indicate rejection, tests based on a new model allowing for potential – but unrealized – regime shifts provide support for the expectations hypothesis. The peso problem is modelled by means of a threshold autoregression. The estimation results suggest that potential regime shift had an effect on expectations concerning the longer-term interest rate only for a short while in the early phase of the sample period, when interest rates were at their highest.

Introduction: This paper investigates the evolution of the (conditional) volatility of returns on three Scandinavian markets (Finland, Norway and Sweden) over the turbulent period of the past decade, namely the overlapping periods of financial liberalisation, drastically changing macroeconomic conditions and banking crisis. We find that even over this relatively turbulent period volatility is in most cases successfully captured by past volatility and shocks to past volatility, ie by a (symmetric) GARCH process. In each country banking crisis has induced regime shifts in (unconditional) volatility. We also find evidence for cross-country volatility spillovers during the banking crisis episodes. The estimated volatility patterns suggest that even though the volatility of returns was of very high magnitude during the years of banking crisis, developments within the banking industry were not reflected in market uncertainty until all the damage had been done and the severe problems afflicting banks began to be realised in full.

Author: Ari Hyytinen

Source: Research Discussion Papers, Bank of Finland

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