Alternative Models for Stock Price Dynamics

Mikhail Chernov (), A. Ronald Gallant, Eric Ghysels () and George Tauchen ()

CIRANO Working Papers from CIRANO

Abstract: This paper evaluates the role of various volatility specifications, such as multiple stochastic volatility (SV) factors and jump components, in appropriate modeling of equity return distributions. We use estimation technology that facilitates non-nested model comparisons and use a long data set which provides rich information about the conditional and unconditional distribution of returns. We consider two broad families of models: (1) the multifactor loglinear family, and (2) the affine-jump family. Both classes of models have attracted much attention in the derivatives and econometrics literatures. There are various trade-offs in considering such diverse specifications. If pure diffusion SV models are chosen over jump diffusions, it has important implications for hedging strategies. If logaritmic models are chosen over affine ones, it may seriously complicate option pricing. Comparing many different specifications of pure diffusion multi-factor models and jump diffusion models, we find that (1) log linear models have to be extented to 2 factors with feedback in the mean reverting factor, (2) affine models have to have a jumps in returns, stochastic volatility and probably both. Models (1) and (2) are observationally equivalent on the data set in hand. In either (1) or (2) the key is that the volatility can move violently. As we obtain models with comparable empirical fit, one must make a choice based on arguments other than statistical goodness of fit criteria. The considerations include facility to price options, to hedge and parsimony. The affine specification with jumps in volatility might therefore be preferred because of the closed-form derivatives prices.

Nous examinons un ensemble de diffusions avec volatilité stochastique et de sauts afin de modéliser la distribution des rendements d'actifs boursiers. Puisque certains modèles sont non-emboîtés, nous utilisons la méthode EMM afin d'étudier et de comparer le comportement des différents modèles.

Keywords: Efficient method of moments; Poisson jump processes; stochastic volatility models; Processus de diffusions; processus Poisson; volatilité stochastique (search for similar items in EconPapers)
JEL-codes: G13 C14 C52 C53 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ets, nep-fin and nep-fmk
Date: 2002-06-01
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Related works:
Working Paper: Alternative Models for Stock Price Dynamic (2002)
Journal Article: Alternative models for stock price dynamics (2003)
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Persistent link: http://EconPapers.repec.org/RePEc:cir:cirwor:2002s-58

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