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Continuous-Time Models, Realized Volatilities, and Testable Distributional Implications for Daily Stock Returns

  • Torben G. Andersen
  • Tim Bollerslev
  • Per Houmann Frederiksen
  • Morten Ørregaard Nielsen

    ()

    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

We provide an empirical framework for assessing the distributional properties of daily specu- lative returns within the context of the continuous-time modeling paradigm traditionally used in asset pricing finance. Our approach builds directly on recently developed realized variation measures and non-parametric jump detection statistics constructed from high-frequency intra- day data. A sequence of relatively simple-to-implement moment-based tests involving various transforms of the daily returns speak directly to the import of different features of the under- lying continuous-time processes that might have generated the data. As such, the tests may serve as a useful diagnostic tool in the specification of empirically more realistic asset pricing models. Our results are also directly related to the popular mixture-of-distributions hypoth- esis and the role of the corresponding latent information arrival process. On applying our sequential test procedure to the thirty individual stocks in the Dow Jones Industrial Average index, the data suggest that it is important to allow for both time-varying diffusive volatility, jumps, and leverage effects in order to satisfactorily describe the daily stock price dynamics. At a broader level, the empirical results also illustrate how the realized variation measures and high-frequency sampling schemes may be used in eliciting important distributional features and asset pricing implications more generally.

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Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2007-21.

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Length: 72
Date of creation: 16 Aug 2007
Date of revision:
Handle: RePEc:aah:create:2007-21
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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