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Box-Cox stochastic volatility models with heavy-tails and correlated errors

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  • Zhang, Xibin
  • King, Maxwell L.

Abstract

This paper presents a Markov chain Monte Carlo (MCMC) algorithm to estimate parameters and latent stochastic processes in the asymmetric stochastic volatility (SV) model, in which the Box-Cox transformation of the squared volatility follows an autoregressive Gaussian distribution and the marginal density of asset returns has heavy-tails. We employed the Bayes factor and the Bayesian information criterion (BIC) to examine whether the Box-Cox transformation of squared volatility is favored against the log-transformation. When applying the heavy-tailed asymmetric Box-Cox transformed SV model, three competing SV models and the t-GARCH(1,1) model to continuously compounded daily returns of the Australian stock index, we find that the Box-Cox transformation of squared volatility is strongly favored by Bayes factors and BIC against the log-transformation. While both criteria strongly favor the t-GARCH(1,1) model against the heavy-tailed asymmetric Box-Cox transformed SV model and the other three competing SV models, we find that SV models fit the data better than the t-GARCH(1,1) model based on a measure of closeness between the distribution of the fitted residuals and the distribution of the model disturbance. When our model and its competing models are applied to daily returns of another five stock indices, we find that in terms of SV models, the Box-Cox transformation of squared volatility is strongly favored against the log-transformation for the five data sets.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 15 (2008)
Issue (Month): 3 (June)
Pages: 549-566

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Handle: RePEc:eee:empfin:v:15:y:2008:i:3:p:549-566

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Web page: http://www.elsevier.com/locate/jempfin

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Citations

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Cited by:
  1. Xibin Zhang & Maxwell L. King, 2011. "Bayesian semiparametric GARCH models," Monash Econometrics and Business Statistics Working Papers 24/11, Monash University, Department of Econometrics and Business Statistics.
  2. María José Rodríguez & Esther Ruiz, 2009. "GARCH models with leverage effect : differences and similarities," Statistics and Econometrics Working Papers ws090302, Universidad Carlos III, Departamento de Estadística y Econometría.
  3. Zhang, Xibin & King, Maxwell L., 2008. "Box-Cox stochastic volatility models with heavy-tails and correlated errors," Journal of Empirical Finance, Elsevier, vol. 15(3), pages 549-566, June.
  4. Xibin Zhang & Maxwell L. King, 2013. "Gaussian kernel GARCH models," Monash Econometrics and Business Statistics Working Papers 19/13, Monash University, Department of Econometrics and Business Statistics.
  5. Zhang, Xibin & King, Maxwell L. & Hyndman, Rob J., 2006. "A Bayesian approach to bandwidth selection for multivariate kernel density estimation," Computational Statistics & Data Analysis, Elsevier, vol. 50(11), pages 3009-3031, July.
  6. Georgios Tsiotas, 2009. "On the use of non-linear transformations in Stochastic Volatility models," Statistical Methods and Applications, Springer, vol. 18(4), pages 555-583, November.
  7. Zhongxian Men & Adam W. Kolkiewicz & Tony S. Wirjanto, 2013. "Bayesian Inference of Asymmetric Stochastic Conditional Duration Models," Working Paper Series 28_13, The Rimini Centre for Economic Analysis.
  8. Harvey, A. & Chakravarty, T., 2008. "Beta-t-(E)GARCH," Cambridge Working Papers in Economics 0840, Faculty of Economics, University of Cambridge.

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