We decompose UK market volatility into
short- and long-run components using EGARCH component model and examine the
cross-sectional prices of the two components. Our empirical results suggest
that these two components are significantly priced in the cross-section and the
negative risk premia are consistent with the existing literature. The Fama-French
three-factor model is improved by the inclusion of the two volatility
components. However, our ICAPM model using market excess return and the
decomposed volatility components as state variables compares inferiorly to the
traditional three-factor model.
Cite this paper
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