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The Factor--Spline--GARCH Model for High and Low Frequency Correlations

  • José Gonzalo Rangel
  • Robert F. Engle

We propose a new approach to model high and low frequency components of equity correlations. Our framework combines a factor asset pricing structure with other specifications capturing dynamic properties of volatilities and covariances between a single common factor and idiosyncratic returns. High frequency correlations mean revert to slowly varying functions that characterize long-term correlation patterns. We associate such term behavior with low frequency economic variables, including determinants of market and idiosyncratic volatilities. Flexibility in the time-varying level of mean reversion improves both the empirical fit of equity correlations in the United States and correlation forecasts at long horizons.

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File URL: http://hdl.handle.net/10.1080/07350015.2012.643132
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Article provided by Taylor & Francis Journals in its journal Journal of Business & Economic Statistics.

Volume (Year): 30 (2011)
Issue (Month): 1 (May)
Pages: 109-124

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Handle: RePEc:taf:jnlbes:v:30:y:2011:i:1:p:109-124
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