Mean Reversion of Volatility Around Extreme Stock Returns: Evidence from U.S. Stock Indexes

This paper examines mean reversion processes in volatility structure of stock markets after extremely high or low stock returns. The stock market volatility is reflected in three aspects, overall volatility, volatility momentum, and volatility concentration, and they are measured by three basic statistical measures, variance/standard deviation, skewness, and kurtosis, respectively. The results of this study illustrate remarkable reversions in volatility momentum, concentration, and level between periods of preand post-extremely high stock returns. Evidence of this study also supports some strong volatility reversions after extremely negative stock returns. The findings are helpful to investing professionals and financial policy makers to expand their understanding of different aspects of volatility structure and their change cycles. The knowledge may enhance effectiveness of portfolio managers in risk management after busts of stock price bubbles.