Discussion Papers 2016

CIRJE-F-1019

"Cholesky Realized Stochastic Volatility Model"

Author Name

Shirota, Shinichiro, Yasuhiro Omori, Hedibert. F. Lopes and Haixiang Piao

Date

August 2016

Full Paper

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Remarks

Revised version of CIRJE-F-979 (2015); subsequently published in Econometrics and Statistics, 3, 34-59. July 2017 DOI: 10.1016/j.ecosta.2016.08.003.

Abstract

Multivariate stochastic volatility models with leverage are expected to play important roles in financial applications such as asset allocation and risk management. However, these models suffer from two major difficulties: (1) there are too many parameters to estimate by using only daily asset returns and (2) estimated covariance matrices are not guaranteed to be positive definite. Our approach takes advantage of realized covariances to achieve the efficient estimation of parameters by incorporating additional information for the co-volatilities, and considers Cholesky decomposition to guarantee the positive definiteness of the covariance matrices. In this framework, a exible model is proposed for stylized facts of financial markets, such as dynamic correlations and leverage effects among volatilities. By using the Bayesian approach, Markov Chain Monte Carlo implementation is described with a simple but efficient sampling scheme. Our model is applied to the data of nine U.S. stock returns, and it is compared with other models on the basis of portfolio performances.

Keywords: Cholesky stochastic volatility model; Dynamic correlations, Leverage effect; Markov chain Monte Carlo; Realized covariances