The Use of Risk and Return for Testing the Stability of Stock Markets

The European Central Bank stipulates that a financial system is stable if the financial risks are evaluated and rewarded correctly and if the economic and financial shocks are absorbed. When analyzing the return and volatility of the stock exchanges we may ascertain that a stock exchange is stable if there is a connection between return and volatility and if the shocks determined by the new positive and negative information do not cause significant changes of the volatility. We took into consideration the values of the indices of stock markets from Holland (AEX), Belgium (BEL),Romania (BET), Hungary (BUX), Germany (DAX), France (CAC), Czech Republic (PX), Slovakia(SAX), Austria (ATX), Estonia (OMXT), Latvia (OMXR) and Lithuania (OMXV). In order to test the relationship between return-volatility and volatility asymmetry we estimated a GJR-GARCH-M model. The results confirm the lack of existence of a correlation between return and volatility for the entire period under analysis and the existence of the volatility asymmetry.