Research in International Business and Finance 25 (2011) 329–334 Contents lists available at ScienceDirect Research in International Business and Finance journal homepage: www.elsevier.com/locate/ribaf The dynamic interaction between volatility and returns in the US stock market using leveraged bootstrap simulations Abdulnasser Hatemi-J * , Manuchehr Irandoust Department of Economics and Finance, UAE University, P.O. Box 17555, Al Ain, United Arab Emirates a r t i c l e i n f o Article history: Received 28 November 2010 Received in revised form 3 March 2011 Accepted 15 March 2011 Available online 25 March 2011 JEL classification: G10 C30 Keywords: Volatility Returns Causality Leveraged bootstrapping a b s t r a c t One of the most important stylized facts in finance is that stock index returns are inversely related to volatility. The theoretical rationale behind the proposition is still controversial. The causal relationship between returns and volatility is investigated in the US stock market over the period 2004–2009 using daily data. We apply a bootstrap test with leveraged adjustments that is robust to non-normality and ARCH. We find that the volatility causes returns negatively and returns cause volatility positively. The policy impli- cations of our findings are discussed in the main text. © 2011 Elsevier B.V. All rights reserved. 1. Introduction The underlying link between the return on a financial asset and its variance or volatility as a proxy for risk is of fundamental importance for valuing financial assets, for identifying optimal hedging strategies and for evaluating regulatory proposals on monitoring the impact of international capital flows. Therefore, the theoretical asset pricing models (e.g., Sharpe, 1964; Merton, 1973) are based on the interaction between returns and risk. However, it is still controversial whether such a rela- tionship is positive or negative, i.e., a fully acceptable economic clarification for the effect has not yet been offered (Bouchaud et al., 2001; Bollerslev and Zhou, 2006). Although most asset pricing models highlight a positive link between stock portfolio’s expected returns and volatility (Baillie and * Corresponding author. E-mail addresses: AHatemi@uaeu.ac.ae (A. Hatemi-J), MEirandoust@uaeu.ac.ae (M. Irandoust). 0275-5319/$ – see front matter © 2011 Elsevier B.V. All rights reserved. doi:10.1016/j.ribaf.2011.03.001