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Independent component analysis for realized volatility: Analysis of the stock market crash of 2008

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  • Kumiega, Andrew
  • Neururer, Thaddeus
  • Van Vliet, Ben
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    Abstract

    This paper investigates the factors that drove the U.S. equity market returns from 2007 to early 2010. The period was highlighted by volatile energy and commodity prices, the collapse of insurance and banking firms, extreme implied volatility and a subsequent rally in the overall market. To extract the driving factors, we decompose the returns of the S&P500 sector ETFs into statistically independent signals using independent component analysis. We find that the generated factors have interesting financial interpretations and are consistent with the major economic themes of the period. We find that there are two sets of general market betas during the period along with a dominant factor for energy and materials sector. In addition, we find that the EGARCH model which accommodates asymmetric responses between returns and volatility can plausibly fit the high levels of variance during the crash. Finally, estimated correlations dropped when commodity prices moved higher, but then spiked when the S&P500 crashed in late 2008.

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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 51 (2011)
    Issue (Month): 3 (June)
    Pages: 292-302

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    Handle: RePEc:eee:quaeco:v:51:y:2011:i:3:p:292-302

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    Web page: http://www.elsevier.com/locate/inca/620167

    Related research

    Keywords: Independent component analysis EGARCH Equity index volatility;

    References

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    1. Ledoit, Olivier & Santa-Clara, Pedro & Wolf, Michael, 1999. "Flexible Multivariate GARCH Modeling With an Application to International Stock Markets," University of California at Los Angeles, Anderson Graduate School of Management qt93s6p8gb, Anderson Graduate School of Management, UCLA.
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