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Fat Tails and Asymmetry in Financial Volatility Models

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Author Info
Peter Verhoeven (School of Economics and Finance, Curtin University of Technology)
Michael McAleer (Department of Economics, University of Western Australia)

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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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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
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Handle: RePEc:tky:fseres:2003cf211

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  2. Gonzalez-Rivera, Gloria & Drost, Feike C., 1999. "Efficiency comparisons of maximum-likelihood-based estimators in GARCH models," Journal of Econometrics, Elsevier, vol. 93(1), pages 93-111, November. [Downloadable!] (restricted)
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  6. Tim Bollerslev & Jeffrey Wooldridge, 1992. "Quasi-maximum likelihood estimation and inference in dynamic models with time-varying covariances," Econometric Reviews, Taylor and Francis Journals, vol. 11(2), pages 143-172. [Downloadable!] (restricted)
  7. Ling, Shiqing & McAleer, Michael, 2002. "Stationarity and the existence of moments of a family of GARCH processes," Journal of Econometrics, Elsevier, vol. 106(1), pages 109-117, January. [Downloadable!] (restricted)
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Cited by:
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  1. Paola Palmitesta & Corrado Provasi, 2004. "GARCH-type Models with Generalized Secant Hyperbolic Innovations," Studies in Nonlinear Dynamics & Econometrics, Berkeley Electronic Press, vol. 8(2), pages 1212-1212. [Downloadable!] (restricted)
  2. Gamini Premaratne & Prabhath Jayasinghe, 2005. "Exchange rate exposure of stock returns at firm level," International Finance 0503004, EconWPA. [Downloadable!]
  3. Fulvio Corsi & Uta Kretschmer & Stefan Mittnik & Christian Pigorsch, 2005. "The Volatility of Realized Volatility," CFS Working Paper Series 2005/33, Center for Financial Studies. [Downloadable!]
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