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Financial density selection

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  • J. Miguel Marin
  • Genaro Sucarrat

Abstract

We propose and study simple but flexible methods for density selection of skewed versions of the two most popular density classes in finance, the exponential power distribution and the t distribution. For the first type of method, which simply consists of selecting a density by means of an information criterion, the Schwarz criterion stands out since it performs well across density categories, and in particular when the DGP is normal. For the second type of method, general-to-specific density selection, the simulations suggest that it can improve the recovery rate in predictable ways by changing the significance level. This is useful because it enables us to increase (reduce) the recovery rate of non-normal densities by increasing (reducing) the significance level, if one wishes to do so. The third type of method is a generalisation of the second type, such that it can be applied across an arbitrary number of density classes, nested or non-nested. Finally, the methods are illustrated in an empirical application.

Suggested Citation

  • J. Miguel Marin & Genaro Sucarrat, 2015. "Financial density selection," The European Journal of Finance, Taylor & Francis Journals, vol. 21(13-14), pages 1195-1213, November.
    • Handle: RePEc:taf:eurjfi:v:21:y:2015:i:13-14:p:1195-1213
    DOI: 10.1080/1351847X.2012.706906
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    More about this item

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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