Asymmetric Volatility and Dynamic Asset Allocation

Abstract

This paper devises a stochastic volatility feedback (SVF) model to investigate the economic importance of the leverage and volatility feedback effects, both of which are the two main explanations for volatility asymmetry. We perform the dynamic asset allocation model under the SVF model and then assess the economic performances for the corresponding optimal investment strategies. Our findings are as follows. (i) the volatility feedback effect drives the intertemporal hedging demand, in contrast, the leverage effect has a minor effect on it; (ii) a longer investment horizon or a higher current volatility enhance the volatility feedback effect; (iii) ignoring the volatility feedback effect would suffer from tremendous economic loss.