Risk-Return Relationship for Stock-Market Investments: A Study of the Implied Volatility Index of Japan (VXJ)

The aim of this study is to examine the information content of implied volatility index of Japan (VXJ) and to determine the risk-return relationship for Japanese markets. Present paper also investigates the predictive power of VXJ. The quantile regression method and Granger causality test is applied for the empirical analysis. The major finding of study is that VXJ volatility index responds asymmetrically to the positive and negative NIKKEI 225 index returns and the asymmetry increases from the median quantile towards the upper most quantile in a monotonic manner. Secondly, the asymmetry occurs contemporaneously rather than at lagged returns or past returns, thereby rejecting leverage and volatility feedback hypothesis. However, behavioral explanations such affect and representativeness heuristic can explain this asymmetric shortterm relationship in a better way. Thirdly, predictive power of implied volatility is also determined by analyzing its relationship with realized volatility derived from intraday squared returns. The results express that implied volatility is a partial and efficient predictor of future realized variance. The major implication of this paper can be for Japanese investors, portfolio managers and policy makers. Firstly, policymakers should officially develop a volatility index for investors which in Japanese markets which can be used for developing strategies for trading and profitbooking in the markets. This index can act as benchmark index for predicting future uncertainties in the market. This paper is novel in studying the risk-return relation using implied volatility index of Japan. To the best of author’s knowledge till now there is no study in which statistical properties and behavior of VXJ is studied.