Asymmetric Response of Public Utility Stock Returns Volatility to Up and Down Markets and Deregulation

Abstract

This investigation researches how industry institutional regimes can affect the pattern and volatility of stock prices and returns. This paper searches for information signals of regulatory policy in US electric public utility company stock returns and also tests for volatility changes from the buffering effect from deregulation. Utility stock returns asymmetry in up and down markets is modeled for evidence of investor information signals of regulatory behavior. Lax regulation should lead to utility stock returns that react strongly to up markets due to weakly-constrained expected upside profits. Utility stock returns should have a small response to down markets. Stringent regulation should generate the opposite result. Since stock returns distributions typically have skewness and kurtosis, this study applies flexible probability density function (pdf) regressions methods that accommodate skewness and kurtosis. This paper concludes that since utility stock returns have a strong response to down markets relative to up markets, there is down market asymmetry in price and returns volatility. This evidence suggests that investors perceive that utility profit regulation is stringent. It also suggests, surprisingly, that the buffering effect has been increased with deregulation. Lastly, robust estimation of financial models performed herein shows that regression estimation should not assume a normally distributed error term.