Modelling conditional correlations of asset returns: A smooth transition approach
AbstractIn this paper we propose a new multivariate GARCH model with time-varying conditional correlation structure. The time-varying conditional correlations change smoothly between two extreme states of constant correlations according to a predetermined or exogenous transition variable. An LM-test is derived to test the constancy of correlations and LM- and Wald tests to test the hypothesis of partially constant correlations. Analytical expressions for the test statistics and the required derivatives are provided to make computations feasible. An empirical example based on daily return series of five frequently traded stocks in the S&P 500 stock index completes the paper.
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Bibliographic InfoPaper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2012-09.
Date of creation: 02 2012
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Web page: http://www.econ.au.dk/afn/
GARCH; Constant conditional correlation; Dynamic conditional correlation; Return comovement; Variable correlation GARCH model; Volatility model evaluation;
Find related papers by JEL classification:
- C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G1 - Financial Economics - - General Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-03-14 (All new papers)
- NEP-ECM-2012-03-14 (Econometrics)
- NEP-ETS-2012-03-14 (Econometric Time Series)
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