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Flexible Dynamic Conditional Correlation multivariate GARCH models for asset allocation

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Author Info

  • Monica Billio
  • Massimiliano Caporin
  • Michele Gobbo

Abstract

This paper introduces the Flexible Dynamic Conditional Correlation (FDCC) multivariate GARCH model which generalizes the Dynamic Conditional Correlation (DCC) multivariate GARCH model proposed by Engle (2002). The FDCC model relax the assumption of common dynamics among all assets used in the DCC model. In fact, we cannot impose that the correlation dynamics of, say, European sectorial stock indexes are identical to the corresponding US ones. We thus extend the DCC model introducing a block-diagonal structure; in the FDCC the dynamics are constrained to be equal among groups of variables. We present an application to a sectorial asset allocation problem.

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Bibliographic Info

Article provided by Taylor and Francis Journals in its journal Applied Financial Economics Letters.

Volume (Year): 2 (2006)
Issue (Month): 2 (March)
Pages: 123-130

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Handle: RePEc:taf:apfelt:v:2:y:2006:i:2:p:123-130

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References

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  1. David Morelli, 2003. "Capital asset pricing model on UK securities using ARCH," Applied Financial Economics, Taylor & Francis Journals, vol. 13(3), pages 211-223.
  2. Soosung Hwang & Steve Satchell, 2005. "GARCH model with cross-sectional volatility: GARCHX models," Applied Financial Economics, Taylor & Francis Journals, vol. 15(3), pages 203-216.
  3. Tak-Kee Hui, 2005. "Portfolio diversification: a factor analysis approach," Applied Financial Economics, Taylor & Francis Journals, vol. 15(12), pages 821-834.
  4. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  5. Robert F. Engle & Kevin Sheppard, 2001. "Theoretical and Empirical properties of Dynamic Conditional Correlation Multivariate GARCH," NBER Working Papers 8554, National Bureau of Economic Research, Inc.
  6. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
  7. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
  8. James Chong, 2004. "Options trading profits from correlation forecasts," Applied Financial Economics, Taylor & Francis Journals, vol. 14(15), pages 1075-1085.
  9. Bollerslev, Tim & Engle, Robert F. & Nelson, Daniel B., 1986. "Arch models," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 49, pages 2959-3038 Elsevier.
  10. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
  11. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  12. Helen Higgs & Andrew Worthington, 2004. "Transmission of returns and volatility in art markets: a multivariate GARCH analysis," Applied Economics Letters, Taylor & Francis Journals, vol. 11(4), pages 217-222.
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