Keran Song and Prasad VB
Two models are developed in this paper in order to discuss possible asymmetric business cycle effects on US sectoral stock returns. One is a GARCH model with asymmetric explanatory variables and the other one is an ARCH-M model with asymmetric external regressors. In the second model, square root of conditional variance of the business cycle proxy is characterized as positive or negative risk, depending on the algebraic sign of past innovations driving the business cycle proxy. This helps to capture any asymmetric effects of positive and negative business cycle risk on returns. We find that some sectors change their cyclicities from expansions to recessions. Negative shocks to business cycles have most power to influence sectoral volatilities. Positive and negative parts of business cycle risk have same effects on some sectors but have opposite effects on other sectors. A general conclusion of both models is that business cycles has stronger effects than own sectoral effects in driving sectoral returns.