What They Did Not Tell You About Algebraic (Non-)Existence, Mathematical (IR-)Regularity and (Non-)Asymptotic Properties of the Dynamic Conditional Correlation (DCC) Model

Michael McAleer

No EI2019-13, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

Abstract: In order to hedge efficiently, persistently high negative covariances or, equivalently, correlations, between risky assets and the hedging instruments are intended to mitigate against financial risk and subsequent losses. If there is more than one hedging instrument, multivariate covariances and correlations will have to be calculated. As optimal hedge ratios are unlikely to remain constant using high frequency data, it is essential to specify dynamic time-varying models of covariances and correlations. These values can either be determined analytically or numerically on the basis of highly advanced computer simulations. Analytical developments are occasionally promulgated for multivariate conditional volatility models. The primary purpose of the paper is to analyse purported analytical developments for the only multivariate dynamic conditional correlation model to have been developed to date, namely Engle’s (2002) widely-used Dynamic Conditional Correlation (DCC) model. Dynamic models are not straightforward (or even possible) to translate in terms of the algebraic existence, underlying stochastic processes, specification, mathematical regularity conditions, and asymptotic properties of consistency and asymptotic normality, or the lack thereof. The paper presents a critical analysis, discussion, evaluation and presentation of caveats relating to the DCC model, and an emphasis on the numerous dos and don’ts in implementing the DCC and related model in practice

Keywords: Hedging; covariances; correlations; existence; mathematical regularity; invertibility; likelihood function; statistical asymptotic properties; caveats; practical implementation (search for similar items in EconPapers)
JEL-codes: C22 C32 C51 C52 C58 C62 G32 (search for similar items in EconPapers)
Pages: 16
Date: 2019-03-01
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-rmg
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Citations: View citations in EconPapers (19)

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Related works:
Journal Article: What They Did Not Tell You about Algebraic (Non-) Existence, Mathematical (IR-)Regularity, and (Non-) Asymptotic Properties of the Dynamic Conditional Correlation (DCC) Model (2019)
Working Paper: What They Did Not Tell You About Algebraic (Non-)Existence, Mathematical (IR-)Regularity and (Non-)Asymptotic Properties of the Dynamic Conditional Correlation (DCC) Model (2019)
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