COMFORT: A Common Market Factor Non-Gaussian Returns Model

Marc S. Paolella and Pawel Polak
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Marc S. Paolella: University of Zurich - Department of Banking and Finance; Swiss Finance Institute
Pawel Polak: University of Zurich; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

No 13-38, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: A new multivariate time series model with various attractive properties is motivated and studied. By extending the CCC model in several ways, it allows for all the primary stylized facts of financial asset returns, including volatility clustering, non-normality (excess kurtosis and asymmetry), and also dynamics in the dependency between assets over time. A fast EM-algorithm is developed for estimation. Each element of the vector return at time t is endowed with a common univariate shock, interpretable as a common market factor. This leads to the new model being a hybrid of GARCH and stochastic volatility, but without the estimation problems associated with the latter, and being applicable in the multivariate setting for potentially large numbers of assets. A feasible technique which allows for multivariate option pricing is presented, along with an empirical illustration.

Keywords: CCC; Common Jumps; Density Forecasting; EM-Algorithm; Fat Tails; GARCH; Multivariate Asymmetric Variance Gamma Distribution; Multivariate Generalized Hyperbolic Distribution; Multivariate Option Pricing; Stochastic Volatility (search for similar items in EconPapers)
JEL-codes: C51 C53 G11 G17 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2013-07, Revised 2014-09
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1338

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