Structural Change and Diagnosis of Nepalese Stock Market Volatility

Abstract

In modern finance, understanding the interplay between risk and return is fundamental. Traditionally seen as the average variability of returns, volatility has gained significance in investment decisions. However, the conventional view of volatility as a constant has given way to the concept of conditional volatility, acknowledging its time-dependent nature affected by various factors, including lagged conditional variance and information shocks. This study diagnoses the impact of incorporating deterministic structural shifts while evaluating the persistence and leverage effect in the volatility of the Nepal Stock Exchange, which was largely underrepresented in extant empirical works. A family of asymmetric GARCH specifications were used to diagnose persistence and leverage effect with and without deterministic structural shifts. The results confirmed the downward adjustment of volatility persistence and leverage effect when such deterministic structural shifts are incorporated in the specification. Moreover, persistence and volatility effects facilitated inferences regarding the degree of market efficiency of the Nepal Stock Exchange, revealing a weak-form inefficiency.