Indirect estimation of GARCH models with alpha-stable innovations
AbstractSeveral studies have highlighted the fact that heavy-tailedness of asset returns can be the consequence of conditional heteroskedasticity. GARCH models have thus become very popular, given their ability to account for volatility clustering and, implicitly, heavy tails. However, these models encounter some difficulties in handling financial time series, as they respond equally to positive and negative shocks and their tail behavior remains too short even with Student-t error terms. To overcome these weaknesses we apply GARCH-type models with alpha-stable innovations. The stable family of distributions constitutes a generalization of the Gaussian distribution that has intriguing theoretical and practical properties. Indeed it is stable under addiction and, having four parameters, it allows for asymmetry and heavy tails. Unfortunately stable models do not have closed likelihood function, but since simulated values from α-stable distributions can be straightforwardly obtained, the indirect inference approach is particularly suited to the situation at hand. In this work we provide a description of how to estimate a GARCH(1,1) and a TGARCH(1,1) with symmetric stable shocks using as auxiliary model a GARCH(1,1) with skew-t innovations. Monte Carlo simulations, conducted using GAUSS, are presented and finally the proposed models are used to estimate the IBM weekly return series as an illustration of how they perform on real data.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 38544.
Date of creation: 18 Apr 2012
Date of revision:
GARCH; alpha-stable distribution; indirect estimation; skew-t distribution; Monte Carlo simulations;
Find related papers by JEL classification:
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- C87 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Econometric Software
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-05-15 (All new papers)
- NEP-ECM-2012-05-15 (Econometrics)
- NEP-ETS-2012-05-15 (Econometric Time Series)
- NEP-ORE-2012-05-15 (Operations Research)
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