The Factor-Spline-GARCH Model for High and Low Frequency Correlations

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The Factor-Spline-GARCH Model for High and Low Frequency Correlations

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Jose Gonzalo Rangel
Robert F. Engle

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Abstract

We propose a new approach to model high and low frequency components of equity correlations. Our framework combines a factor asset pricing structure with other specifications capturing dynamic properties of volatilities and covariances between a single common factor and idiosyncratic returns. High frequency correlations mean revert to slowly varying functions that characterize long-term correlation patterns. We associate such term behavior with low frequency economic variables, including determinants of market and idiosyncratic volatilities. Flexibility in the time varying level of mean reversion improves the empirical fit of equity correlations in the US and correlation forecasts at long horizons.

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Paper provided by Banco de México in its series Working Papers with number 2009-03.

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Date of creation: Feb 2009
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Handle: RePEc:bdm:wpaper:2009-03

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Web page: http://www.banxico.org.mx
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Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-03-14 (All new papers)
NEP-ECM-2009-03-14 (Econometrics)
NEP-ETS-2009-03-14 (Econometric Time Series)
NEP-MST-2009-03-14 (Market Microstructure)

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This page was last updated on 2009-11-26.

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