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Modeling foreign exchange rates with jumps

  • John M Maheu
  • Thomas H McCurdy

We propose a new discrete-time model of returns in which jumps capture persistence in the conditional variance and higher-order moments. Jump arrival is governed by a heterogeneous Poisson process. The intensity is directed by a latent stochastic autoregressive process, while the jump-size distribution allows for conditional heteroskedasticity. Model evaluation focuses on the dynamics of the conditional distribution of returns using density and variance forecasts. Predictive likelihoods provide a period-by-period comparison of the performance of our heterogeneous jump model relative to conventional SV and GARCH models. Further, in contrast to previous studies on the importance of jumps, we utilize realized volatility to assess out-of-sample variance forecasts.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-279.

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Length: 34 pages
Date of creation: 02 Feb 2007
Date of revision:
Handle: RePEc:tor:tecipa:tecipa-279
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  17. GORDON, Stephen, 1995. "Stochastic Trends, Deterministic Trends and Business Cycle Turning Points," Cahiers de recherche 9503, Université Laval - Département d'économique.
  18. Melino, Angelo & Turnbull, Stuart M., 1990. "Pricing foreign currency options with stochastic volatility," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 239-265.
  19. Sassan Alizadeh & Michael W. Brandt & Francis X. Diebold, 2002. "Range-Based Estimation of Stochastic Volatility Models," Journal of Finance, American Finance Association, vol. 57(3), pages 1047-1091, 06.
  20. Torben G. Andersen & Luca Benzoni & Jesper Lund, 2001. "An Empirical Investigation of Continuous-Time Equity Return Models," NBER Working Papers 8510, National Bureau of Economic Research, Inc.
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