Inverse Realized Laplace Transforms for Nonparametric Volatility Estimation in Jump-Diffusions
AbstractWe develop a nonparametric estimator of the stochastic volatility density of a discretely-observed Ito semimartingale in the setting of an increasing time span and finer mesh of the observation grid. There are two steps. The first is aggregating the high-frequency increments into the realized Laplace transform, which is a robust nonparametric estimate of the underlying volatility Laplace transform. The second step is using a regularized kernel to invert the realized Laplace transform. The two steps are relatively quick and easy to compute, so the nonparametric estimator is practicable. We derive bounds for the mean squared error of the estimator. The regularity conditions are sufficiently general to cover empirically important cases such as level jumps and possible dependencies between volatility moves and either diffusive or jump moves in the semimartingale. Monte Carlo work indicates that the nonparametric estimator is reliable and reasonably accurate in realistic estimation contexts. An empirical application to 5-minute data for three large-cap stocks, 1997-2010, reveals the importance of big short-term volatility spikes in generating high levels of stock price variability over and above that induced by price jumps. The application also shows how to trace out the dynamic response of the volatility density to both positive and negative jumps in the stock price.
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Bibliographic InfoPaper provided by Duke University, Department of Economics in its series Working Papers with number 11-21.
Date of creation: 2011
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Laplace transform; stochastic volatility; ill-posed problems; regularization; nonparametric density estimation; high-frequency data;
Find related papers by JEL classification:
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-11-14 (All new papers)
- NEP-ECM-2011-11-14 (Econometrics)
- NEP-ETS-2011-11-14 (Econometric Time Series)
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