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Equity index variance: Evidence from flexible parametric jump–diffusion models

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  • Kaeck, Andreas
  • Rodrigues, Paulo
  • Seeger, Norman J.

Abstract

This paper analyzes a wide range of flexible drift and diffusion specifications of stochastic-volatility jump–diffusion models for daily S&P 500 index returns. We find that model performance is driven almost exclusively by the specification of the diffusion component whereas the drift specifications is of second-order importance. Further, the variance dynamics of non-affine models resemble popular non-parametric high-frequency estimates of variance, and their outperformance is mainly accumulated during turbulent market regimes. Finally, we show that jump diffusion models yield more reliable estimates for the expected return of variance swap contracts.

Suggested Citation

  • Kaeck, Andreas & Rodrigues, Paulo & Seeger, Norman J., 2017. "Equity index variance: Evidence from flexible parametric jump–diffusion models," Journal of Banking & Finance, Elsevier, vol. 83(C), pages 85-103.
    • Handle: RePEc:eee:jbfina:v:83:y:2017:i:c:p:85-103
    DOI: 10.1016/j.jbankfin.2017.06.010
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    More about this item

    Keywords

    Stochastic volatility; Jump–diffusion models; Bayesian inference; Markov chain Monte Carlo; Particle filter; Deviance information criteria; Realized variance; High-frequency returns; Variance risk premium;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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