Models of Financial Return With Time-Varying Zero Probability

Genaro Sucarrat and Steffen Grønneberg

MPRA Paper from University Library of Munich, Germany

Abstract: The probability of an observed financial return being equal to zero is not necessarily zero. This can be due to price discreteness or rounding error, liquidity issues (e.g. low trading volume), market closures, data issues (e.g. data imputation due to missing values), characteristics specific to the market, and so on. Moreover, the zero probability may change and depend on market conditions. In standard models of return volatility, however, e.g. ARCH, SV and continuous time models, the zero probability is zero, constant or both. We propose a new class of models that allows for a time-varying zero probability, and which can be combined with standard models of return volatility: They are nested and obtained as special cases when the zero probability is constant and equal to zero. Another attraction is that the return properties of the new class (e.g. volatility, skewness, kurtosis, Value-at-Risk, Expected Shortfall) are obtained as functions of the underlying volatility model. The new class allows for autoregressive conditional dynamics in both the zero probability and volatility specifications, and for additional covariates. Simulations show parameter and risk estimates are biased if zeros are not appropriately handled, and an application illustrates that risk-estimates can be substantially biased in practice if the time-varying zero probability is not accommodated.

Keywords: Financial return; volatility; zero-inflated return; GARCH; log-GARCH; ACL (search for similar items in EconPapers)
JEL-codes: C01 C22 C32 C51 C52 C58 (search for similar items in EconPapers)
Date: 2016-01-17
New Economics Papers: this item is included in nep-ecm and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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https://mpra.ub.uni-muenchen.de/77264/8/MPRA_paper_77264.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/81882/15/MPRA_paper_81882.pdf revised version (application/pdf)

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