A New Approach to Volatility Modeling: The High-Dimensional Markov Model
Maciej Augustyniak (),
Luc Bauwens () and
Arnaud Dufays ()
Additional contact information
Maciej Augustyniak: Université de Montréal
Luc Bauwens: Université catholique de Louvain, CORE, Belgium
Arnaud Dufays: Université Laval
No 2016042, CORE Discussion Papers from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)
A new model – the high-dimensional Markov (HDM) model – is proposed for financial returns and their latent variances. It is also applicable to model directly realized variances. Volatility is modeled as a product of three components: a Markov chain driving volatility persistence, an independent discrete process capable of generating jumps in the volatility, and a predictable (data-driven) process capturing the leverage effect. The Markov chain and jump components allow volatility to switch abruptly between thousands of states. The transition probability matrix of the Markov chain is structured in such a way that the multiplicity of the second largest eigenvalue can be greater than one. This distinctive feature generates a high degree of volatility persistence. The statistical properties of the HDM model are derived and an economic interpretation is attached to each component. In-sample results on six financial time series highlight that the HDM model compares favorably to the main existing volatility processes. A forecasting experiment shows that the HDM model significantly outperforms its competitors when predicting volatility over time horizons longer than five days.
Keywords: Volatility; Markov-switching; Persistence; Leverage effect (search for similar items in EconPapers)
JEL-codes: C22 C51 C58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-for and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations Track citations by RSS feed
Downloads: (external link)
https://alfresco-guest.uclouvain.be/alfresco/servi ... df?a=true&guest=true (application/pdf)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: http://EconPapers.repec.org/RePEc:cor:louvco:2016042
Access Statistics for this paper
More papers in CORE Discussion Papers from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) Voie du Roman Pays 34, 1348 Louvain-la-Neuve (Belgium). Contact information at EDIRC.
Series data maintained by Alain GILLIS ().