Multivariate asset return prediction with mixture models

Marc S. Paolella

The European Journal of Finance, 2015, vol. 21, issue 13-14, 1214-1252

Abstract: The use of mixture distributions for modeling asset returns has a long history in finance. New methods of demonstrating support for the presence of mixtures in the multivariate case are provided. The use of a two-component multivariate normal mixture distribution, coupled with shrinkage via a quasi-Bayesian prior, is motivated, and shown to be numerically simple and reliable to estimate, unlike the majority of multivariate GARCH models in existence. Equally important, it provides a clear improvement over use of GARCH models feasible for use with a large number of assets, such as constant conditional correlation, dynamic conditional correlation, and their extensions, with respect to out-of-sample density forecasting. A generalization to a mixture of multivariate Laplace distributions is motivated via univariate and multivariate analysis of the data, and an expectation-maximization algorithm is developed for its estimation in conjunction with a quasi-Bayesian prior. It is shown to deliver significantly better forecasts than the mixed normal, with fast and numerically reliable estimation. Crucially, the distribution theory required for portfolio theory and risk assessment is developed.

Date: 2015
References: Add references at CitEc
Citations: View citations in EconPapers (11)

Downloads: (external link)
http://hdl.handle.net/10.1080/1351847X.2012.760167 (text/html)
Access to full text is restricted to subscribers.

Related works:
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: https://EconPapers.repec.org/RePEc:taf:eurjfi:v:21:y:2015:i:13-14:p:1214-1252

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/REJF20

DOI: 10.1080/1351847X.2012.760167

Access Statistics for this article

The European Journal of Finance is currently edited by Chris Adcock

More articles in The European Journal of Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().