Non-Linear Trade Off between Risk and Return: A Regime-Switching Multi-Factor Framework

Financial planners face a consistent challenge to help clients understand the trade-off between risk and return. Most clients relate to the idea of a targeted level of expected return to achieve specific wealth goals but with limited understanding of the required risk. Extended investment horizons require client discipline when market volatility appears to be enhancing the possibility of loss of wealth. The purpose of this article is to illustrate that bearing the risk associated with market volatility can reward clients with the achievement of targeted portfolio returns, even during times of great financial and economic uncertainty. Data from 1994 to 2013 is used to create hypothetical portfolios consisting of stock and bond allocations designed to target specific client return objectives. Graphical charts illustrate the resulting annual volatility associated with multiyear investment horizons. Financial planners can use these examples to better communicate the historical volatility associated with portfolios constructed to deliver target levels of return to clients.

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On Relation Between Margin and Conditional Volatility in Japanese Stock Market

Journal of Derivatives and Quantitative Studies ◽

10.1108/jdqs-04-2010-b0003 ◽

2010 ◽

Vol 18 (4) ◽

pp. 51-68

Author(s):

Pan-Do Sohn ◽

Sung-Shin Kim ◽

Jung-Soon Shin

Keyword(s):

Stock Market ◽

Empirical Test ◽

Conditional Volatility ◽

Positive Relation ◽

Risk And Return ◽

Trade Off ◽

Bear Market ◽

Asymmetric Volatility ◽

Policy Tool ◽

Market State

This paper investigates the asymmetric volatility between conditional volatility and initial margin using daily market return of TOPIX and Nikkei225 over 1970 to 1990. In prior studies, generally, it has been known that margin is regard as a main discipline to control volatility with respect to a policy tool. Our empirical test provides the following results. First, this paper shows that there is significantly positive relation between return of stock market and margin, implying that as margin increases, also return increases. Thus we conclude that the trade-off of risk and return is found. Second, our result suggests that in normal state, margin affects to conditional volatility negatively and significantly, indicating that margin policy could control the conditional volatility. Third, this paper finds that in recession state, there is little bit evidence of discipline action in controlling volatility. Fourth, our paper also finds that in boom state, there is adversely evidence of margin on conditional volatility. As a result, government has motivation to decrease the volatility in bull market state, whereas it also has motivation to increase the volatility in bear market state. Our paper finds the evidence that the motive for changing the margin is fitted to normal and boom state. Therefore, our result suggests that government has to adjust the change of margin policy adequately to fit the market conditions.

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