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ABC of SV: Limited information likelihood inference in stochastic volatility jump-diffusion models

Michael Creel () and Dennis Kristensen ()

Journal of Empirical Finance, 2015, vol. 31, issue C, 85-108

Abstract: We develop novel methods for estimation and filtering of continuous-time models with stochastic volatility and jumps using so-called Approximate Bayesian Computation which build likelihoods based on limited information. The proposed estimators and filters are computationally attractive relative to standard likelihood-based versions since they rely on low-dimensional auxiliary statistics and so avoid computation of high-dimensional integrals. Despite their computational simplicity, we find that estimators and filters perform well in practice and lead to precise estimates of model parameters and latent variables. We show how the methods can incorporate intra-daily information to improve on the estimation and filtering. In particular, the availability of realized volatility measures help us in learning about parameters and latent states. The method is employed in the estimation of a flexible stochastic volatility model for the dynamics of the S&P 500 equity index. We find evidence of the presence of a dynamic jump rate and in favor of a structural break in parameters at the time of the recent financial crisis. We find evidence that possible measurement error in log price is small and has little effect on parameter estimates. Smoothing shows that, recently, volatility and the jump rate have returned to the low levels of 2004–2006.

Keywords: Approximate Bayesian Computation; Continuous-time processes; Filtering; Indirect inference; Jumps; Realized volatility (search for similar items in EconPapers)
JEL-codes: C13 C14 C15 C33 G17 (search for similar items in EconPapers)
Date: 2015
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Working Paper: ABC of SV: Limited Information Likelihood Inference in Stochastic Volatility Jump-Diffusion Models (2014) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:31:y:2015:i:c:p:85-108

DOI: 10.1016/j.jempfin.2015.01.002

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Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

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