A new approach to volatility modeling: the High-Dimensional Markov model

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15 Décembre 2016
Types de publication: 
Cahier de recherche
Arnaud Dufays
Maciej Augustyniak
Luc Bauwens
Axe de recherche: 
Enjeux économiques et financiers
Leverage effect
Classification JEL: 

A new model - the factorial hidden Markov volatility (FHMV) model - is proposed for financial returns and their latent variances. It is also applicable to model directly realized variances. Volatility is modeled as a product of three components: a Markov chain driving volatility persistence, an independent discrete process capable of generating jumps in the volatility, and a predictable (data-driven) process capturing the leverage effect. An economic interpretation is attached to each one of these components. Moreover, the Markov chain and jump components allow volatility to switch abruptly between thousands of states, and the transition matrix of the model is structured in such a way as to generate a high degree of volatility persistence. In-sample results on six financial time series highlight that the FHMV process compares favorably to state-of-the-art volatility models. A forecasting experiment shows that it also outperforms its competitors when predicting volatility over time horizons ranging from one to one hundred days.


Maciej Augustyniak : Département de mathématiques et de statistique, Université de Montréal ; Quantact
Actuarial and Financial Mathematics Laboratory ; augusty@dms.umontreal.ca
Luc Bauwens : Université catholique de Louvain, CORE, B-1348 Louvain-La-Neuve, Belgium ; Université
Côte d'Azur - SKEMA, France ; luc.bauwens@uclouvain.be
Arnaud Dufays : Département d'économique, UniversitéLaval, 1025 avenue des Sciences-Humaines,
Quebec City, Quebec ; arnaud.dufays@ecn.ulaval.ca