p–ISSN: 2723 - 6609 e-ISSN: 2745-5254

Vol. 5, No. 4 April 2024 http://jist.publikasiindonesia.id/

Indonesian Journal of Social Technology, Vol. 5, No. 4, April, 2024 1798

Risk Premium and Volatility Analysis on the Indonesia Stock

Exchange

Syanindita Prameswari

, Adler Haymans Manurung

2

*Correspondence

and indicates the risks investors face. High volatility is a characteristic of high risk and

high potential returns. Understanding the volatility of an investment asset gives investors

the insight to manage their portfolios more closely and achieve optimal investment

returns.

Market risk premium and market volatility are essential in investment decisions.

Volatility is a vital variable in derivative securities that measures changes in stock returns.

Aggregate stock market volatility has been used as an economic indicator by financial

economics concerned with government policy. Fund managers usually pay attention to

risk premiums and volatility when determining asset allocation through efficient limit

estimation (Manurung, 1997). Annin & Falaschetti (1998) define the equity risk premium

market volatility has a positive relationship with the market risk premium, but there is no

significant difference with zero.

Research on volatility has been conducted by previous researchers conducted by

Banumathy & Azhagaiah (2015) on the stock market in India (Lin, 2018) tested stock

volatility in China using the GARCH model (Nghi & Kieu, 2021) on Japanese and

Vietnamese stocks, and (Yahaya et al., 2023) delves into stock volatility in Nigeria

(NGX). Meanwhile, research on risk premiums was, among others, conducted by

(Morawakage et al., 2019) and (Yue et al.

While many studies have focused on the volatility of stock returns, research on the

risk premium in emerging markets has been limited. As such, this research is new and

or commodity in a certain period. Since volatility can be represented by standard

deviation, the public also considers volatility as a form of risk. The higher the level of

volatility, the greater the uncertainty associated with the return that can be obtained from

stocks. Stocks included in the price index face a dynamic market, considering market

participants can quickly enter or leave the market (Mukmin & Firmansyah, 2015).

Thus, we can conclude that volatility is a variation in stock movements that can be

measured by standard deviation, reflecting an unstable nature and difficult to predict.

Equity Risk Premium (ERP) has been the focus of attention in asset pricing

literature over a long period due to its significant role in determining the expected rate of

return on investment. Annin & Falaschetti (1998) focused on ERP by introducing the

premium but does not show a significant difference. Meanwhile, (Morawakage et al. show

that there is no direct relationship between volatility and risk premium.

Research Methods

This research uses daily closing price data of the Indonesia Stock Exchange

Composite Index (JCI). This index has a weighted value and includes all stocks listed on

Indonesian Journal of Social Technology, Vol. 5, No. 4, April, 2024 1800

by downloading daily composite stock price index data on the Yahoo Finance website.

ARCH-GARCH

The ARCH model was initially developed by Engle (1982). ARCH expresses that

under the random variable y, taken from the conditional density

oneuoneconeiononenononone󰇛



 󰇜, eestimatedvalueoof

todayedependsonpaseperformanceoreeileaan s oallows







The above equation is called ARCH(q). This reveals that conditional variance

changes over time due to past errors, leaving a constant unconditional variance (W).

Ow: 

















end subscript must be positive in the GARCH process (1,1) (to produce that all sigma sub

t squared is positive.

The risk premium is the difference between market returns and risk-free interest

rates and led: 

 



……………. (4)

Where,

R

= Stock returns for the i period

Indonesia. Return is the total gain or loss from an investment over time. Monthly returns

are chosen to calculate volatility based on daily data. Marke returns are calculated as

follows: 



󰇛



󰇜 ……………. (5)

Where,

I

t

= Market indices at the end of the month t

Indonesian Journal of Social Technology, Vol. 5, No. 4, April, 2024 1802

period.

Descriptive Statistics

Table 2 illustrates the descriptive statistics of the calculated risk premium for the

Indonesian market. Results corresponding to the Jarque-Bera test for normality are also

presented in Table 2.

Table 2

The average daily risk premium is positive in Indonesia at 0.11%. Indonesia's risk

premium indicates relatively greater unconditional volatility based on standard deviation.

varies with time.

model GARCH (1,1): 

  





 











……………. (7a)









neere, 

Equation (7b) reveals that the coefficient at the lag of the squared error is positive.

The lag of the conditional variance of this term is very significantly different from zero,

but the lag of the squared error is not significantly different from zero.

Risk is significant in the Capital Asset Pricing Model (CAPM). These results can

help decision-makers for investors predict market risk using last month's market risk. If

the market becomes more volatile this month, risk-averse investors can enter it. However,

Indonesian Journal of Social Technology, Vol. 5, No. 4, April, 2024 1804

The estimated risk premium of Indonesia Stock Exchange (IDX) aggregate sha

ow Cap









……………. (8)

risk premium. Equation (8) can be used to estimate the risk-free rate, which is often

Conclusion

This study's conclusion is to test whether there is a relationship between the

volatility of return and risk premium in the Indonesian stock market. Using the daily trend

of the Indonesian stock market (IDX) from January 2010 to September 2023. We use the

GARCH model (1,1). The methodology used here differs from previous studies that

mainly used the usual least squares time series (OLS) method to estimate the GARCH

coefficient and risk premium. It was found that there is a relationship between risk

premium and volatility in the Indonesian stock market.

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