Improving the asymmetric stochastic volatility model with ex-post volatility: the identification of the asymmetry

Zehua Zhang and Ran Zhao

Quantitative Finance, 2023, vol. 23, issue 1, 35-51

Abstract: Simulation studies show that the asymmetry stochastic volatility (ASV) models may infer erroneous correlation coefficients, due to their predetermined return-volatility specification. We propose identifying the correlation parameter by incorporating the ex-post volatility in the ASV framework. We obtain a significantly smaller magnitude in the estimated correlation coefficients between equity and volatility processes among major U.S. equity market indexes. Out-of-sample index return distribution forecasts demonstrate superior performance when jointly estimating the return and the ex-post volatility processes. The corrected return-volatility correlations by estimating proposed ASV models with subsample data further document the time-varying leverage effect.

Date: 2023
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DOI: 10.1080/14697688.2022.2140700

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