Multivariate Estimator Of Volatility Patterns And Risk-Return Trade-Off In The Behaviour Of Equity Prices – The Nigerian Evidence

ABSTRACT

The incentive for risk-bearing is central to activities in the capital market; and the perception of fair reward system, which reflects in securities prices, attracts more participants and stimulates new investments. Following what is often described as foundation of finance; a rational investor, in his utility preference dynamics, loves return but hates risk. Notwithstanding that this axiom rooted in the random-walk framework has shaped normative thinking in finance, empirical evidence appears less convincing on the exact nature of risk-return relationship. This study sought to investigate equity price behaviour as reflected in volatility patterns and risk-return relationship using a more relevant framework. Following the foundation laid by Engle, Bollerslev and Wooldridge (1988); Zakoan (1994) and Glosten, Jagannathan and Runkle (1993), the researcher formulated unique Multivariate Vec ThresholdGARCH-in-Mean models and fitted these to weekly sample of 21 securities return series for period 1999-2008. Earlier studies of securities prices on Nigeria were limited to the traditional and univariate GARCH frameworks which have been shown to be less suitable for portfolio management. Using maximum likelihood estimation technique, the Researcher ran scalar and rank one regressions on 10,962 observations in the series and found that the Log Excess Return model variant was able to explain the stylized facts of price volatility namely persistence and asymmetry. These patterns were found to be significant and suggest existence of opportunities to earn abnormal returns in the market. The study found that idea of risk-return trade-off is perhaps more general than depicted by traditional literature. The regressions showed appropriately that „conditional variance risk‟ is significantly priced at positive premium by investors. However using the „conditional covariance risk‟, the study found compelling but surprising evidence of negative risk-return trade-off suggesting existence of dis-incentive to take additional risk by rational investors. This seemingly anomalous result which reflects enormous challenges faced in portfolio optimization and capital formation processes in the Nigeria market could be a consequence of badly behaved capital market line and indifference curve that characterize most markets that operate outside equilibrium. The study also found that detection of trade- off is more of long run phenomenon while regularity of patterns diminished as one moved from less to more active securities and markets. The researcher accordingly recommends among others; active portfolio management by informed investors, reduction in transaction costs, enhanced information flow, market de-leveraging and sensible diversification as factors that may optimize risk-return trade-off relations.