The threshold effect in expected volatility: a model based on asymmetric information

This article develops theoretical insight into the thresholdeffect in expected volatility, which means that large shocksare less persistent in volatility than small shocks. The modeluses the Kyle-Admati-Pfleiderer setup with liquidity traders,informed traders, and a market maker. Information is modeledas a GARCH process. It is shown that the GARCH process for informationis transformed into a TARCH process (for 'threshold GARCH')for the market price changes. Working with information flowsallows one to derive implications for trading volume and marketliquidity which provide the basis for a more complete test ofthe model.