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Financial Density Selection

J. Miguel Marin and Genaro Sucarrat

MPRA Paper from University Library of Munich, Germany

Abstract: We propose and study simple but flexible methods for density selection of skewed versions of the two most popular density classes in finance, the exponential power distribution and the t distribution. For the first type of method, which simply consists of selecting a density by means of an information criterion, the Schwarz criterion stands out since it performs well across density categories, and in particular when the Data Generating Process is normal. For the second type of method, General-to-Specific density selection, the simulations suggest that it can improve the recovery rate in predictable ways by changing the significance level. This is useful because it enables us to increase (reduce) the recovery rate of non-normal densities by increasing (reducing) the significance level, if one wishes to do so. The third type of method is a generalisation of the second type, such that it can be applied across an arbitrary number of density classes, nested or non-nested. Finally, the methods are illustrated in an empirical application.

Keywords: Financial returns; density selection; skewed exponential power distribution; skewed t distribution; general-to-specific density selection (search for similar items in EconPapers)
JEL-codes: C52 C58 (search for similar items in EconPapers)
Date: 2012-08-31, Revised 2012-06-13
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Published in The European Journal of Finance 13-14.21(2015): pp. 1195-1213

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