Alternative Models for Stock Price Dynamic

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

No 02-03, Working Papers from Duke University, Department of Economics

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 logarithmic 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 extended to 2 factors with feedback in the mean reverting factor, (2) affine models have to have a jump in returns, stochastic volatility or 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.

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
View citations in EconPapers

Downloads: (external link)
http://www.econ.duke.edu/Papers/Abstracts02/abstract.02.03.html main text

Related works:
Working Paper: Alternative Models for Stock Price Dynamics (2002)
Journal Article: Alternative models for stock price dynamics (2003)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:duk:dukeec:02-03

Access Statistics for this paper

More papers in Working Papers from Duke University, Department of Economics
Address: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
Series data maintained by Department of Economics Webmaster ().