A Threshold Stochastic Volatility Model with Realized Volatility
AbstractRapid development in the computer technology has made the financial transaction data visible at an ultimate limit level. The realized volatility, as a proxy for the "true" volatility, can be constructed using the high frequency data. This paper extends a threshold stochastic volatility specification proposed in So, Li and Lam (2002) by incorporating the high frequency volatility measures. Due to the availability of the volatility time series, the parameters estimation can be easily implemented via the standard maximum likelihood estimation (MLE) rather than using the simulated Bayesian methods. In the Monte Carlo section, several mis-specification and sensitivity experiments are conducted. The proposed methodology shows good performance according to the Monte Carlo results. In the empirical study, three stock indices are examined under the threshold stochastic volatility structure. Empirical results show that in different regimes, the returns and volatilities exhibit asymmetric behavior. In addition, this paper allows the threshold in the model to be flexible and uses a sequential optimization based on MLE to search for the "optimal" threshold value. We find that the model with a flexible threshold is always preferred to the model with a fixed threshold according to the log-likelihood measure. Interestingly, the "optimal" threshold is found to be stable across different sampling realized volatility measures.
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Bibliographic InfoPaper provided by University of Waterloo, Department of Economics in its series Working Papers with number 1003.
Length: 29 pages
Date of creation: May 2010
Date of revision: May 2010
Find related papers by JEL classification:
- C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-05-15 (All new papers)
- NEP-ECM-2010-05-15 (Econometrics)
- NEP-ETS-2010-05-15 (Econometric Time Series)
- NEP-MST-2010-05-15 (Market Microstructure)
- NEP-ORE-2010-05-15 (Operations Research)
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