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FRS17 and the Sterling Doubles A Corporate Yield Curve

  • Frank Skinner

    ()

    (ICMA Centre, University of Reading)

  • Michalis Ioannides

    (Watson Wyatt LLP, UK)

Registered author(s):

    The skewness in physical distributions of equity index returns and the implied volatility skew in the risk-neutral measure are subjects of extensive academic research. Much attention is now being focused on models that are able to capture time-varying conditional skewness and kurtosis. For this reason normal mixture GARCH(1,1) models have become very popular in financial econometrics. We introduce further asymmetries into this class of models by modifying the GARCH(1,1) variance processes to skewed variance processes with leverage effects. These asymmetric normal mixture GARCH models can differentiate between two different sources of asymmetry: a persistent asymmetry due to the different means in the conditional normal mixture distributions, and a dynamic asymmetry (the leverage effect) due to the skewed GARCH processes. Empirical results on five major equity indices first employ many statistical criteria to determine whether asymmetric (GJR and AGARCH) normal mixture GARCH models can improve on asymmetric normal and Student’s-t GARCH specifications. These models were also used to simulate implied volatility smiles for the S&P index, and we find that much the most realistic skews are obtained from a GARCH model with a mixture of two GJR variance components.

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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2004-09.pdf
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    Paper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2004-08.

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    Length: 24 pages
    Date of creation: Jun 2004
    Date of revision:
    Publication status: Published in International Journal of Theoretical & Applied Finance 2006, 9:2, 415-437
    Handle: RePEc:rdg:icmadp:icma-dp2004-08
    Contact details of provider: Postal: PO Box 218, Whiteknights, Reading, Berks, RG6 6AA
    Phone: +44 (0) 118 378 8226
    Fax: +44 (0) 118 975 0236
    Web page: http://www.henley.reading.ac.uk/
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    1. repec:dgr:uvatin:19990027 is not listed on IDEAS
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    3. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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    6. Mark Fisher & Douglas Nychka & David Zervos, 1995. "Fitting the term structure of interest rates with smoothing splines," Finance and Economics Discussion Series 95-1, Board of Governors of the Federal Reserve System (U.S.).
    7. McCulloch, J Huston, 1975. "The Tax-Adjusted Yield Curve," Journal of Finance, American Finance Association, vol. 30(3), pages 811-30, June.
    8. Robert A. Jarrow, 2009. "The Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 69-96, November.
    9. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
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