A Stochastic Volatility Model with Conditional Skewness
AbstractWe develop a discrete-time affine stochastic volatility model with time-varying conditional skewness (SVS). Importantly, we disentangle the dynamics of conditional volatility and conditional skewness in a coherent way. Our approach allows current asset returns to be asymmetric conditional on current factors and past information, what we term contemporaneous asymmetry. Conditional skewness is an explicit combination of the conditional leverage effect and contemporaneous asymmetry. We derive analytical formulas for various return moments that are used for generalized method of moments estimation. Applying our approach to S&P500 index daily returns and option data, we show that one- and two-factor SVS models provide a better fit for both the historical and the risk-neutral distribution of returns, compared to existing affine generalized autoregressive conditional heteroskedasticity (GARCH) models. Our results are not due to an overparameterization of the model: the one-factor SVS models have the same number of parameters as their one-factor GARCH competitors.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 11-20.
Length: 58 pages
Date of creation: 2011
Date of revision:
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Asset Pricing; Econometric and statistical methods;
Find related papers by JEL classification:
- C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
- C5 - Mathematical and Quantitative Methods - - Econometric Modeling
- G1 - Financial Economics - - General Financial Markets
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-11-07 (All new papers)
- NEP-ECM-2011-11-07 (Econometrics)
- NEP-ETS-2011-11-07 (Econometric Time Series)
- NEP-ORE-2011-11-07 (Operations Research)
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