Volatility Components, Affine Restrictions, and Nonnormal Innovations
AbstractRecent work by Engle and Lee (1999) shows that allowing for long-run and short-run components greatly enhances a GARCH modelâs ability fit daily equity return dynamics. Using the risk-neutralization in Duan (1995), we assess the option valuation performance of the Engle-Lee model and compare it to the standard one-component GARCH(1,1) model. We also compare these non-affine GARCH models to one- and two- component models from the class of affine GARCH models developed in Heston and Nandi (2000). Using the option pricing methodology in Duan (1999), we then compare the four conditionally normal GARCH models to four conditionally non-normal versions. As in Hsieh and Ritchken (2005), we find that non-affine models dominate affine models both in terms of fitting return and in terms of option valuation. For the affine models we find strong evidence in favor of the component structure for both returns and options, but for the non-affine models the evidence is much less strong in option valuation. The evidence in favor of the non-normal models is strong when fitting daily returns, but the non-normal models do not provide much improvement when valuing options.
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Bibliographic InfoArticle provided by American Statistical Association in its journal Journal of Business and Economic Statistics.
Volume (Year): 28 (2010)
Issue (Month): 4 ()
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Other versions of this item:
- Peter Christoffersen & Kris Dorion & Yintian Wang, 2008. "Volatility Components, Affine Restrictions and Non-Normal Innovations," CREATES Research Papers 2008-10, School of Economics and Management, University of Aarhus.
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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