Abstract
Markov Regime-Switching Generalized Autoregressive Conditional Heteroskedastic (MRS-GARCH) model is a widely used approach to model the financial volatility with potential structural breaks. The original innovation of the MRS-GARCH model is assumed to follow the Normal distribution, which cannot accommodate fat-tailed properties commonly existing in financial time series. Many existing studies point out that this problem can lead to inconsistent estimates. To overcome it, the Student's t-distribution and General Error Distribution (GED) are the two most popular alternatives. However, a recent study points out that the Student's t-distribution lacks stability. Instead, this research incorporates the a-stable distribution in the GARCH-type model. The issue of the a-stable distribution is that its second moment does not exist. To solve this problem, the tempered stable distribution, which retains most characteristics of the a-stable distribution and has defined moments, is a natural candidate. In this paper, we conduct a series of simulation studies to demonstrate that MRS-GARCH model with tempered stable distribution consistently outperform that with Student's t-distribution and GED. Our empirical study on the S&P 500 daily return volatility also generates robust results. Therefore, we argue that the tempered stable distribution could be a widely useful tool for modelling the financial volatility in general contexts with a MRS-GARCH-type specification.
Original language | English |
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Title of host publication | MODSIM 2015 |
Subtitle of host publication | Proceedings of the 21st International Congress on Modelling and Simulation |
Editors | Tony Weber, Malcolm McPhee, Robert Anderssen |
Place of Publication | Gold Coast |
Publisher | Modelling and Simulation Society of Australia and New Zealand |
Pages | 994-1000 |
Number of pages | 7 |
ISBN (Electronic) | 9780987214355 |
DOIs | |
Publication status | Published - 2015 |
Externally published | Yes |
Event | 21st International Congress on Modelling and Simulation: Partnering with Industry and the Community for Innovation and Impact through Modelling, MODSIM 2015 - Held jointly with the 23rd National Conference of the Australian Society for Operations Research and the DSTO led Defence Operations Research Symposium, DORS 2015 - Broadbeach, Australia Duration: 29 Nov 2015 → 4 Dec 2015 |
Conference
Conference | 21st International Congress on Modelling and Simulation: Partnering with Industry and the Community for Innovation and Impact through Modelling, MODSIM 2015 - Held jointly with the 23rd National Conference of the Australian Society for Operations Research and the DSTO led Defence Operations Research Symposium, DORS 2015 |
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Country/Territory | Australia |
City | Broadbeach |
Period | 29/11/15 → 4/12/15 |
Keywords
- Fat-tailed distribution
- GARCH Model
- Regime-switching
- Tempered stable distribution