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Volatilities and Conditional Correlations in Futures Markets with a Multivariate t Distribution

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  • M. Hashem Pesaran
  • Bahram Pesaran

Abstract

This paper considers a multivariate t version of the Gaussian dynamic conditional correlation (DCC) model proposed by Engle (2002), and suggests the use of devolatized returns computed as returns standardized by realized volatilities rather than by GARCH type volatility estimates. The t-DCC estimation procedure is applied to a portfolio of daily returns on currency futures, government bonds and equity index futures. The results strongly reject the normal-DCC model in favour of a t-DCC specification. The t-DCC model also passes a number of VaR diagnostic tests over an evaluation sample. The estimation results suggest a general trend towards a lower level of return volatility, accompanied by a rising trend in conditional cross correlations in most markets; possibly reflecting the advent of euro in 1999 and increased interdependence of financial markets.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2007/wp-cesifo-2007-07/cesifo1_wp2056.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2056.

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Date of creation: 2007
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Handle: RePEc:ces:ceswps:_2056

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Related research

Keywords: volatilities and correlations; futures market; multivariate t; financial interdependence; VaR diagnostics;

References

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  1. Hashem Pesaran & Paolo Zaffaroni & Banca d'Italia), 2004. "Model Averaging and Value-at-Risk based Evaluation of Large Multi Asset Volatility Models for Risk Management," Money Macro and Finance (MMF) Research Group Conference 2004, Money Macro and Finance Research Group 101, Money Macro and Finance Research Group.
  2. Sébastien Laurent & Luc Bauwens & Jeroen V. K. Rombouts, 2006. "Multivariate GARCH models: a survey," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 21(1), pages 79-109.
  3. Fiorentini, Gabriele & Sentana, Enrique & Calzolari, Giorgio, 2003. "Maximum Likelihood Estimation and Inference in Multivariate Conditionally Heteroscedastic Dynamic Regression Models with Student t Innovations," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 21(4), pages 532-46, October.
  4. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Ebens, Heiko, 2001. "The distribution of realized stock return volatility," Journal of Financial Economics, Elsevier, Elsevier, vol. 61(1), pages 43-76, July.
  5. Jose A. Lopez, 1998. "Methods for evaluating value-at-risk estimates," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Oct, pages 119-124.
  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. Robert Engle & Simone Manganelli, 2000. "CAViaR: Conditional Autoregressive Value at Risk by Regression Quantiles," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 0841, Econometric Society.
  8. Andersen T. G & Bollerslev T. & Diebold F. X & Labys P., 2001. "The Distribution of Realized Exchange Rate Volatility," Journal of the American Statistical Association, American Statistical Association, American Statistical Association, vol. 96, pages 42-55, March.
  9. BAUWENS, Luc & LAURENT, Sébastien, . "A new class of multivariate skew densities, with application to generalized autoregressive conditional heteroscedasticity models," CORE Discussion Papers RP, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) -1793, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  10. Christoffersen, Peter F, 1998. "Evaluating Interval Forecasts," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 841-62, November.
  11. M. Hashem Pesaran & Allan Timmermann, 2004. "Real Time Econometrics," CESifo Working Paper Series, CESifo Group Munich 1169, CESifo Group Munich.
  12. Sentana, E., 1994. "The Likelihood Function of a Conditionally Heteroskdastic Factor Model with Heywood Cases," Papers, Centro de Estudios Monetarios Y Financieros- 9420, Centro de Estudios Monetarios Y Financieros-.
  13. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, Cambridge University Press, vol. 11(01), pages 122-150, February.
  14. Berkowitz, Jeremy, 2001. "Testing Density Forecasts, with Applications to Risk Management," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 19(4), pages 465-74, October.
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Citations

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Cited by:
  1. Robert Engle & Neil Shephard & Kevin Shepphard, 2008. "Fitting vast dimensional time-varying covariance models," OFRC Working Papers Series, Oxford Financial Research Centre 2008fe30, Oxford Financial Research Centre.
  2. Bahram Pesaran & M. Hashem Pesaran, 2010. "Conditional Volatility and Correlations of Weekly Returns and the VaR Analysis of 2008 Stock Market Crash," CESifo Working Paper Series, CESifo Group Munich 3023, CESifo Group Munich.
  3. Andre A. P. & Francisco J. Nogales & Esther Ruiz, 2009. "Comparing univariate and multivariate models to forecast portfolio value-at-risk," Statistics and Econometrics Working Papers, Universidad Carlos III, Departamento de Estadística y Econometría ws097222, Universidad Carlos III, Departamento de Estadística y Econometría.

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