Dynamic Feedback Effect And Skewness In Non-Stationary Stochastic Volatility Model With Leverage

Sujay Mukhoti

No 145, Working papers from Indian Institute of Management Kozhikode

Abstract: In this paper I present a new single factor model for assets return observed in discrete time and its latent volatility with a common “market factor”. This model attempts to unify the concept of feedback effect and skewness in return distribution. Further, it generalizes existing stochastic volatility model with constant feedback to a framework with time varying feedback. As an immediate consequence dynamic skewness and leverage effect follows. However, the dynamic structure violates weakstationarity assumption usually considered for the heteroskedastic models for returns and hence the concept of bounded stationarity is introduced to address the issue of nonstationarity. The single factor model also helps to reduce the number of parameters to be estimated compared to existing SV models with separate feedback and skewness parameters. A characterization of the error distributions for returns and volatility is provided on the basis of existence of conditional moments. Finally, an application of the model has been explained with Normal error and half Normal market factor distribution.

Pages: 27 pages
New Economics Papers: this item is included in nep-ecm
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