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Specification testing in discretized diffusion models: Theory and practice

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  • Gao, Jiti
  • Casas, Isabel

Abstract

We propose two new tests for the specification of both the drift and the diffusion functions in a discretized version of a semiparametric continuous-time financial econometric model. Theoretically, we establish some asymptotic consistency results for the proposed tests. Practically, a simple selection procedure for the bandwidth parameter involved in each of the proposed tests is established based on the assessment of the power function of the test under study. To the best of our knowledge, this is the first approach of this kind in specification of continuous-time financial econometrics. The proposed theory is supported by good small and medium-sample studies.

Suggested Citation

  • Gao, Jiti & Casas, Isabel, 2008. "Specification testing in discretized diffusion models: Theory and practice," Journal of Econometrics, Elsevier, vol. 147(1), pages 131-140, November.
    • Handle: RePEc:eee:econom:v:147:y:2008:i:1:p:131-140
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    References listed on IDEAS

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    1. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
    2. Gao, Jiti, 2007. "Nonlinear time series: semiparametric and nonparametric methods," MPRA Paper 39563, University Library of Munich, Germany, revised 01 Sep 2007.
    3. Li, Qi, 1999. "Consistent model specification tests for time series econometric models," Journal of Econometrics, Elsevier, vol. 92(1), pages 101-147, September.
    4. Yongmiao Hong, 2005. "Nonparametric Specification Testing for Continuous-Time Models with Applications to Term Structure of Interest Rates," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 37-84.
    5. Yacine Aït-Sahalia, 2001. "Transition Densities For Interest Rate And Other Nonlinear Diffusions," World Scientific Book Chapters,in: Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume II), chapter 1, pages 1-34 World Scientific Publishing Co. Pte. Ltd..
    6. Manuel Arapis & Jiti Gao, 2006. "Empirical Comparisons in Short-Term Interest Rate Models Using Nonparametric Methods," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(2), pages 310-345.
    7. Corradi, Valentina & Swanson, Norman R., 2005. "Bootstrap specification tests for diffusion processes," Journal of Econometrics, Elsevier, vol. 124(1), pages 117-148, January.
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    12. Chen, Song Xi & Gao, Jiti, 2007. "An adaptive empirical likelihood test for parametric time series regression models," Journal of Econometrics, Elsevier, vol. 141(2), pages 950-972, December.
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    Cited by:

    1. Chen, Qiang & Zheng, Xu & Pan, Zhiyuan, 2015. "Asymptotically distribution-free tests for the volatility function of a diffusion," Journal of Econometrics, Elsevier, vol. 184(1), pages 124-144.
    2. repec:eee:csdana:v:56:y:2012:i:12:p:3975-3987 is not listed on IDEAS
    3. Monsalve-Cobis, Abelardo & González-Manteiga, Wenceslao & Febrero-Bande, Manuel, 2011. "Goodness-of-fit test for interest rate models: An approach based on empirical processes," Computational Statistics & Data Analysis, Elsevier, vol. 55(12), pages 3073-3092, December.
    4. repec:spr:compst:v:32:y:2017:i:4:d:10.1007_s00180-016-0685-z is not listed on IDEAS
    5. Wenceslao González-Manteiga & Rosa Crujeiras, 2013. "An updated review of Goodness-of-Fit tests for regression models," TEST: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer;Sociedad de Estadística e Investigación Operativa, vol. 22(3), pages 361-411, September.

    More about this item

    Keywords

    Continuous-time diffusion process Kernel method Nonparametric testing Power function Size function Time series econometrics;

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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