Box-Cox stochastic volatility models with heavy-tails and correlated errors

Xibin Zhang () and Maxwell King

Journal of Empirical Finance, 2008, vol. 15, issue 3, 549-566

Abstract: This paper presents a Markov chain Monte Carlo (MCMC) algorithm to estimate parameters and latent stochastic processes in the asymmetric stochastic volatility (SV) model, in which the Box-Cox transformation of the squared volatility follows an autoregressive Gaussian distribution and the marginal density of asset returns has heavy-tails. We employed the Bayes factor and the Bayesian information criterion (BIC) to examine whether the Box-Cox transformation of squared volatility is favored against the log-transformation. When applying the heavy-tailed asymmetric Box-Cox transformed SV model, three competing SV models and the t-GARCH(1,1) model to continuously compounded daily returns of the Australian stock index, we find that the Box-Cox transformation of squared volatility is strongly favored by Bayes factors and BIC against the log-transformation. While both criteria strongly favor the t-GARCH(1,1) model against the heavy-tailed asymmetric Box-Cox transformed SV model and the other three competing SV models, we find that SV models fit the data better than the t-GARCH(1,1) model based on a measure of closeness between the distribution of the fitted residuals and the distribution of the model disturbance. When our model and its competing models are applied to daily returns of another five stock indices, we find that in terms of SV models, the Box-Cox transformation of squared volatility is strongly favored against the log-transformation for the five data sets.

Date: 2008
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Citations: View citations in EconPapers (13)

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Working Paper: Box-Cox Stochastic Volatility Models with Heavy-Tails and Correlated Errors (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:15:y:2008:i:3:p:549-566

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