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

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  • Zehua Zhang
  • Ran Zhao

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.

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  • Zehua Zhang & Ran Zhao, 2023. "Improving the asymmetric stochastic volatility model with ex-post volatility: the identification of the asymmetry," Quantitative Finance, Taylor & Francis Journals, vol. 23(1), pages 35-51, January.
    • Handle: RePEc:taf:quantf:v:23:y:2023:i:1:p:35-51
    DOI: 10.1080/14697688.2022.2140700
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    Cited by:

    1. Li, Chenxing & Zhang, Zehua & Zhao, Ran, 2024. "Volatility or higher moments: Which is more important in return density forecasts of stochastic volatility model?," Finance Research Letters, Elsevier, vol. 67(PB).
    2. Zhang, Zehua & Zhao, Ran, 2023. "Good volatility, bad volatility, and the cross section of cryptocurrency returns," International Review of Financial Analysis, Elsevier, vol. 89(C).

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