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Fat Tails and Asymmetry in Financial Volatility Models

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  • Peter Verhoeven

    (School of Economics and Finance, Curtin University of Technology)

  • Michael McAleer

    (Department of Economics, University of Western Australia)

Abstract

Although the GARCH model has been quite successful in capturing important empirical aspects of financial data, particularly for the symmetric effects of volatility, it has had far less success in capturing the effects of extreme observations, outliers and skewness in returns. This paper examines the GARCH model under various non-normal error distributions in order to evaluate skewness and leptokurtosis. The empirical results show that GARCH models estimated using asymmetric leptokurtic distributions are superior to their counterparts estimated under normality, in terms of: (i) capturing skewness and leptokurtosis; (ii) the maximized log-likelihood values; and (iii) isolating the ARCH and GARCH parameter estimates from the adverse effects of outliers. Overall, the flexible asymmetric Student-t distribution performs best in terms of capturing the non-normal aspects of the data.

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Bibliographic Info

Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-211.

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Length: 18 pages
Date of creation: Mar 2003
Date of revision:
Handle: RePEc:tky:fseres:2003cf211

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Cited by:
  1. Park, Jeong-Soo, 2005. "A simulation-based hyperparameter selection for quantile estimation of the generalized extreme value distribution," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 70(4), pages 227-234.
  2. Zhu, Ke & Li, Wai Keung, 2013. "A new Pearson-type QMLE for conditionally heteroskedastic models," MPRA Paper 52344, University Library of Munich, Germany.
  3. WenShwo Fang & Stephen M. Miller, 2009. "Modeling the Volatility of Real GDP Growth: The Case of Japan Revisited," Working Papers 0904, University of Nevada, Las Vegas , Department of Economics.
  4. Corsi, Fulvio & Kretschmer, Uta & Mittnik, Stefan & Pigorsch, Christian, 2005. "The volatility of realized volatility," CFS Working Paper Series 2005/33, Center for Financial Studies (CFS).
  5. McAleer, Michael & Chan, Felix & Marinova, Dora, 2007. "An econometric analysis of asymmetric volatility: Theory and application to patents," Journal of Econometrics, Elsevier, vol. 139(2), pages 259-284, August.
  6. Zhao, Xin & Scarrott, Carl John & Oxley, Les & Reale, Marco, 2011. "GARCH dependence in extreme value models with Bayesian inference," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 81(7), pages 1430-1440.
  7. Yuichi Nagahara, 2011. "Using Nonnormal Distributions to Analyze the Relationship Between Stock Returns in Japan and the US," Asia-Pacific Financial Markets, Springer, vol. 18(4), pages 429-443, November.
  8. Hayette Gatfaoui, 2010. "Investigating the dependence structure between credit default swap spreads and the U.S. financial market," Annals of Finance, Springer, vol. 6(4), pages 511-535, October.
  9. Amélie Charles, 2008. "Forecasting volatility with outliers in GARCH models," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 27(7), pages 551-565.

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