Econometric Time Series Specification Testing in a Class of Multiplicative Error Models

Abstract

In recent years, analysis of financial time series has focused largely on data related to market trading activity. Apart from modelling the conditional variance of returns within the GARCH family of models, presently attention has also been devoted to other market variables, especially volumes, number of trades and durations. The financial econometrics literature has focused on Multiplicative Error Models (MEMs), which are considered particularly suited for modelling certain financial variables. The paper establishes an econometric specification approach for MEMs. In the literature, several procedures are available to perform specification testing for MEMs, but the proposed specification testing method is particularly useful within the context of the MEMs of financial duration. The paper makes a number of important theoretical contributions. Both the proposed specification testing method and the associated theory are established and evaluated through simulations and real data examples.