Premiums for non-sustainable and sustainable components of market volatility: Evidence from the Korean stock market

Abstract

The study investigates the premiums expected for non-sustainable and sustainable components of market volatility in Korea during the August 1991 to December 2018 period. We decompose market volatility into non-sustainable and sustainable components and construct the factors that mimic the two respective components of market volatility. The portfolio analysis and Fama-MacBeth regressions reveal that both short- and long-term components are negative pricing factors in the Korean stock market. Specifically, stocks with higher sensitivities to the long-term volatility factor have lower average annual returns by approximately 14%, than stocks with lower sensitivities. This implies that stocks with high sensitivity to sustainable volatility provide a hedging opportunity against future uncertainty, and thus, investors are willing to pay an annual premium of 14% for such stocks. Our results are robust to variations in samples and methods.