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Modeling Stochastic Volatility with Application to Stock Returns

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  • Noureddine Krichene
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    Abstract

    A stochastic volatility model where volatility was driven solely by a latent variable called news was estimated for three stock indices. A Markov chain Monte Carlo algorithm was used for estimating Bayesian parameters and filtering volatilities. Volatility persistence being close to one was consistent with both volatility clustering and mean reversion. Filtering showed highly volatile markets, reflecting frequent pertinent news. Diagnostics showed no model failure, although specification improvements were always possible. The model corroborated stylized findings in volatility modeling and has potential value for market participants in asset pricing and risk management, as well as for policymakers in the design of macroeconomic policies conducive to less volatile financial markets.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/125.

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    Length: 27
    Date of creation: 01 Jun 2003
    Date of revision:
    Handle: RePEc:imf:imfwpa:03/125

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    Related research

    Keywords: Stock markets; Economic models; time series; sampling; equation; kurtosis; markov chain; probability; econometrics; skewness; statistics; heteroscedasticity; correlation; normal distribution; prediction; random variables; parameter vector; bayes theorem; monte carlo methods; standard errors; statistic; autocorrelation; time series analysis; equations; mean square; probability distribution; fitted model; time series models; markov chains; outliers; random variable; normal density; statistical methods; diffusion process; computation; logarithm; economic statistics; mathematical statistics; cumulative distribution function; probability models; samples; econometric analysis; goodness of fit; integral; maximum likelihood methods; gaussian distribution; covariance; normal distributions; statistical analysis; regression models; markov process; standard deviation; surveys; conditional expectation; diffusion processes; multivariate distribution; probabilities; bayesian analysis; forecasting;

    References

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    1. GHYSELS, Eric & HARVEY, Andrew & RENAULT, Eric, 1995. "Stochastic Volatility," CORE Discussion Papers 1995069, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    2. Chib, Siddhartha & Nardari, Federico & Shephard, Neil, 2002. "Markov chain Monte Carlo methods for stochastic volatility models," Journal of Econometrics, Elsevier, vol. 108(2), pages 281-316, June.
    3. Chib, Siddhartha, 2001. "Markov chain Monte Carlo methods: computation and inference," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 5, chapter 57, pages 3569-3649 Elsevier.
    4. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
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    7. Chib, Siddhartha & Greenberg, Edward, 1994. "Bayes inference in regression models with ARMA (p, q) errors," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 183-206.
    8. Jacquier, Eric & Polson, Nicholas G & Rossi, Peter E, 1994. "Bayesian Analysis of Stochastic Volatility Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(4), pages 371-89, October.
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    10. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
    11. Harvey, Andrew & Ruiz, Esther & Shephard, Neil, 1994. "Multivariate Stochastic Variance Models," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 247-64, April.
    12. A. W. Coats, 1996. "Introduction," History of Political Economy, Duke University Press, vol. 28(5), pages 3-11, Supplemen.
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    Cited by:
    1. M. Berument & Yeliz Yalcin & Julide Yildirim, 2011. "The inflation and inflation uncertainty relationship for Turkey: a dynamic framework," Empirical Economics, Springer, vol. 41(2), pages 293-309, October.
    2. Bednarik, Radek, 2008. "Analýza volatility devizových kurzů vybraných ekonomik
      [The Analysis of Volatility of Selected Countries' Exchange Rates]
      ," MPRA Paper 15046, University Library of Munich, Germany.

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