Testing the diffusion coefficient
No 2002,38, SFB 373 Discussion Papers from Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes
In mathematical finance diffusion models are widely used and a variety of different parametric models for the drift and diffusion coefficient coexist in the literature. Since derivative prices depend on the particular parametric model of the diffusion coefficient function of the underlying, a misspecification of this function leads to misspecified option prices. We develop two tests about a parametric form of the diffusion coefficient. The finite sample properties of the tests are investigated in a simulation study and the tests are applied to the 7 -day Eurodollar rate, the German stock market index DAX and five German stocks. For all observed processes, we find in the empirical analysis that our tests reject all tested parametric models. We conclude that affine diffusion processes might not be appropriate to model the evolution of financial time series and that a successful model for a financial market should incorporate the history of the observed processes of additional sources of randomness like stochastic volatility models.
Keywords: Diffusion; Continuous-time financial models; Nonparametric methods; Kernel smoothing; Goodness of fit test; spot rate models; interest rate; stock market index; Empirical Likelihood (search for similar items in EconPapers)
JEL-codes: C12 C14 C22 C52 (search for similar items in EconPapers)
References: Add references at CitEc
Citations View citations in EconPapers (2) Track citations by RSS feed
Downloads: (external link)
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:zbw:sfb373:200238
Access Statistics for this paper
More papers in SFB 373 Discussion Papers from Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes Contact information at EDIRC.
Series data maintained by ZBW - German National Library of Economics ().