RISK PERCEPTION AND EQUITY RETURNS: EVIDENCE FROM THE SPX AND VIX

We use the semi‐nonparametric (SNP) model to study the relationship between the innovation of the Volatility Index (VIX) and the expected S&P 500 Index (SPX) returns. We estimate the one‐step‐ahead contemporaneous relation subject to leverage GARCH effect. Results agree with a body of newly established literature arguing non‐linearity, and asymmetries. In addition, the risk‐return behaviour depends on the signs as well as magnitudes of the perceived risk. We conclude that influence of fear or exuberance on the conditional market return is non‐monotonic and hump‐shaped. Very deep fear does not necessarily mean huge losses, instead, the loss may not be as bad as fears of normal levels. Results pass the robustness tests.