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Asymmetry in Stochastic Volatility Models: Threshold or Correlation?

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  • Smith Daniel R

    (Simon Fraser University)

Abstract

We compare the ability of correlation and threshold effects in a stochastic volatility model to capture the asymmetric relationship between stock returns and volatility. The parameters are estimated using maximum likelihood based on the extended Kalman filter and uses numerical integration over the latent volatility process. The stochastic volatility model with only correlation does a better job of capturing asymmetry than a threshold stochastic volatility model even though it has fewer parameters. We develop a stochastic volatility model that includes both threshold effects and correlated innovations. We find that the general model with both threshold effects and correlated innovations dominates purely threshold and correlated models. In this augmented model volatility and returns are negatively correlated, and volatility is more persistent, less volatile and higher following negative returns even after counting for the negative correlation.

Suggested Citation

  • Smith Daniel R, 2009. "Asymmetry in Stochastic Volatility Models: Threshold or Correlation?," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 13(3), pages 1-36, May.
    • Handle: RePEc:bpj:sndecm:v:13:y:2009:i:3:n:1
    DOI: 10.2202/1558-3708.1540
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    2. Montero, José M. & García-Centeno, Maria C. & Fernández-Avilés, Gema, 2011. "Modelling the Volatility of the Spanish Wholesale Electricity Spot Market. Asymmetric GARCH Models vs. Threshold ARSV model/Modelización de la volatilidad en el mercado eléctrico español. Modelos GARC," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 29, pages 597-616, Agosto.
    3. Listorti, Giulia & Esposti, Roberto, 2012. "Horizontal Price Transmission in Agricultural Markets: Fundamental Concepts and Open Empirical Issues," Bio-based and Applied Economics Journal, Italian Association of Agricultural and Applied Economics (AIEAA), vol. 1(1), pages 1-28, April.
    4. Dendramis, Yiannis & Kapetanios, George & Tzavalis, Elias, 2015. "Shifts in volatility driven by large stock market shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 55(C), pages 130-147.
    5. Heejoon Han & Eunhee Lee, 2020. "Triple Regime Stochastic Volatility Model with Threshold and Leverage Effects," Korean Economic Review, Korean Economic Association, vol. 36, pages 481-509.
    6. Mao, Xiuping & Ruiz, Esther & Veiga, Helena, 2017. "Threshold stochastic volatility: Properties and forecasting," International Journal of Forecasting, Elsevier, vol. 33(4), pages 1105-1123.

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