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Estimating Stochastic Cusp Model Using Transition Density

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  • Jan Voříšek

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Abstract

This paper focuses on an econometric model which allows discontinuous change in an explained variable for a small continuous change in parameters. This model, given by stochastic differential equation with cubic drift, is called the cusp within standard catastrophe theory. The closed-form solution of density for this process is known only in the stationary case and this density belongs to the class of generalized exponential distributions, which allows for skewness, different tail shapes and multiple equilibria. The transition density has to be numerically approximated. For that purpose, the finite difference method is employed and then parameters are estimated using the maximum likelihood principle. An empirical example deals with the crash known as Black Monday, where parameters of the drift are driven by market fundamentals.

Suggested Citation

  • Jan Voříšek, 2011. "Estimating Stochastic Cusp Model Using Transition Density," Bulletin of the Czech Econometric Society, The Czech Econometric Society, vol. 18(28).
  • Handle: RePEc:czx:journl:v:18:y:2011:i:28:id:172
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    File URL: http://ces.utia.cas.cz/bulletin/index.php/bulletin/article/view/172
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    Keywords

    stochastic catastrophe theory; cusp; transition density; finite difference;

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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