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A Stochastic Feedback Model for Volatility

  • Raoul Golan
  • Austin Gerig

Financial time series exhibit a number of interesting properties that are difficult to explain with simple models. These properties include fat-tails in the distribution of price fluctuations (or returns) that are slowly removed at longer timescales, strong autocorrelations in absolute returns but zero autocorrelation in returns themselves, and multifractal scaling. Although the underlying cause of these features is unknown, there is growing evidence they originate in the behavior of volatility, i.e., in the behavior of the magnitude of price fluctuations. In this paper, we posit a feedback mechanism for volatility that closely reproduces the non-trivial properties of empirical prices. The model is parsimonious, contains only two parameters that are easily estimated, fits empirical data better than standard models, and can be grounded in a straightforward framework where volatility fluctuations are driven by the estimation error of an exogenous Poisson rate.

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File URL: http://arxiv.org/pdf/1306.4975
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Paper provided by arXiv.org in its series Papers with number 1306.4975.

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Date of creation: Jun 2013
Date of revision: Nov 2013
Handle: RePEc:arx:papers:1306.4975
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