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Modelling time-varying correlations of financial markets

  • A.S.K. Wong
  • P.J.G. Vlaar

In this report we examine time-varying correlations of asset returns using the Dynamic Conditional Correlation (DCC) models, recently proposed by Engle (2002), that are estimated by a two-step procedure. First, we conclude that correlations vary considerably over time. Secondly, the conditional correlations exhibit significantly asymmetric effects for positive and negative asset return shocks. These asymmetric effects differ between stocks and bonds however. Thirdly, the loss of efficiency by using the two-step procedure is relatively large for the standard DCC model, but this procedure reduces the computational burden for the extended specifications. Finally, we compared the standard DCC model to other multivariate GARCH models. The DCC model seems to outperform the alternatives.

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File URL: http://www.dnb.nl/binaries/wo0739_tcm46-146025.pdf
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Paper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 739.

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Length: 36 pages
Date of creation: Sep 2003
Date of revision:
Handle: RePEc:dnb:wormem:739
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  13. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
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