Asymmetric volatility in asset prices: An explanation with mental framing

Heliyon. 2024 Jan 19;10(3):e24978. doi: 10.1016/j.heliyon.2024.e24978. eCollection 2024 Feb 15.

Abstract

We propose a theoretical framework for the heteroscedasticity, and in particular for the asymmetric volatility of asset returns. Our model is based on the assumption that some investors are subject to mental framing in a dynamic setting. The analysis of individual trading data confirms that, in line with our model, investors tilt their portfolio towards riskier (less risky) assets subsequent to losses (gains). Based on their behavior, we derive a volatility process that accounts for the asymmetry thoroughly investigated in previous empirical studies: the parameter estimation of our volatility model yields the predicted negative relationship between abnormal returns and ensuing volatility.

Keywords: Asymmetric volatility; Heuristic-driven trader; Market microstructure; Mental framing; Volatility dynamics.