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Do We Really Need Both BEKK and DCC? A Tale of Two Covariance Models

Author

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  • Massimiliano Caporin

    (Dipartimento di Scienze Economiche "Marco Fanno", Universita degli Studi di Padova)

  • Michael McAleer

    (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo)

Abstract

Large and very large portfolios of financial assets are routine for many individuals and organizations. The two most widely used models of conditional covariances and correlations are BEKK and DCC. BEKK suffers from the archetypal "curse of dimensionality" whereas DCC does not. This is a misleading interpretation of the suitability of the two models to be used in practice. The primary purposes of the paper are to define targeting as an aid in estimating matrices associated with large numbers of financial assets, analyze the similarities and dissimilarities between BEKK and DCC, both with and without targeting, on the basis of structural derivation, the analytical forms of the sufficient conditions for the existence of moments, and the sufficient conditions for consistency and asymptotic normality, and computational tractability for very large (that is, ultra high) numbers of financial assets, to present a consistent two step estimation method for the DCC model, and to determine whether BEKK or DCC should be preferred in practical applications.

Suggested Citation

  • Massimiliano Caporin & Michael McAleer, 2009. "Do We Really Need Both BEKK and DCC? A Tale of Two Covariance Models," CIRJE F-Series CIRJE-F-638, CIRJE, Faculty of Economics, University of Tokyo.
  • Handle: RePEc:tky:fseres:2009cf638
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    References listed on IDEAS

    as
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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