2017
DOI: 10.1515/snde-2016-0047
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Specification analysis in regime-switching continuous-time diffusion models for market volatility

Abstract: We examine model specification in regime-switching continuous-time diffusions for modeling S&P 500 Volatility Index (VIX). Our investigation is carried out under two nonlinear diffusion frameworks, the NLDCEV and the CIRCEV frameworks, and our focus is on the nonlinearity in regime-dependent drift and diffusion terms, the switching components, and the endogeneity in regime changes. While we find strong evidence of regime-switching effects, models with a switching diffusion term capture the VIX dynamics con… Show more

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Cited by 5 publications
(10 citation statements)
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“…A popular choice for various studies in finance assumes that k = 1 and l = 2 or 3 (c.f. Aït-Sahalia, 1996b;Choi, 2009;Kristensen, 2010;Bu, Cheng and Hadri, 2017), in which case the drift has linear or zero mean-reversion in the middle part and much stronger mean-reversion for large and small values of X. Meanwhile, the CEV diffusion term is also consistent with most empirical findings of the shape of the diffusion term.…”
Section: Examples Of Updssupporting
confidence: 79%
“…A popular choice for various studies in finance assumes that k = 1 and l = 2 or 3 (c.f. Aït-Sahalia, 1996b;Choi, 2009;Kristensen, 2010;Bu, Cheng and Hadri, 2017), in which case the drift has linear or zero mean-reversion in the middle part and much stronger mean-reversion for large and small values of X. Meanwhile, the CEV diffusion term is also consistent with most empirical findings of the shape of the diffusion term.…”
Section: Examples Of Updssupporting
confidence: 79%
“…The calibrated parameters of IV, per Equation (2)-CIRCEV specification, including the long-term mean, the reversion rate (half-life), the magnitude in vol-of-vol, together with the CEV skew parameter 1 β > , are all of expected values with a good match to existing literature, such as Ait-Sahalia and Kimmel [27], and Bu et al [28].…”
Section: Stage I-marginal Distributions Of IV and Icmentioning
confidence: 55%
“…For modelling the term structure of interest rates, for example, empirical evidence often …nds one-factor models not …tting short term and long term yields satisfactorily at the same time. In addition, Bu et al (2011) and Bu, Cheng and Hadri (2017) both …nd that TDs with time-varying transformations …t their data signi…cantly better than TDs with constant transformations. Moreover, Forman and Sørensen (2014) …nd their distribution-driven TD model does not …t the autocorrelation structure of their protein unfolding data satisfactorily and subsequently estimate their model with an measurement error.…”
Section: Vxfsmentioning
confidence: 95%
“…Second, simple transformations of a¢ ne models may actually perform better than popular general nonlinear di¤usions. For example, Bu, Cheng and Hadri (2017) …nd that the transformed CIR model with the CEV di¤usion function …ts the VIX data signi…cantly better than the NLDCEV model. Third, TDs inherit many important statistical and dynamic properties from their UDs.…”
Section: Introductionmentioning
confidence: 99%
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