Abstract

http://ssrn.com/abstract=1176203
 
 

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Time-Varying Mixture Multiplicative Error Models for Implied Volatility


Katja Ahoniemi


Imperial College Business School

Markku Lanne


University of Helsinki - Department of Political and Economic Studies

July 17, 2008


Abstract:     
In this paper, we incorporate time-varying mixing probabilities into univariate and bivariate mixture multiplicative error models. Switching between the regimes is governed by an observable predetermined variable. The models are applicable to positive-valued time series, and are particularly well-suited for different financial volatility measures. The flexibility afforded by non-constant regime probabilities facilitates capturing the high persistence in financial volatility regimes, as well as time-varying volatility of volatility. We apply the new models to the implied volatilities of call and put options on the USD/EUR exchange rate, using the lagged daily exchange rate return as the regime indicator. In one-step-ahead forecasting, both mean squared errors and directional accuracy improve when allowing for time-varying mixing probabilities. Further improvements are brought about by employing a bivariate instead of a univariate model.

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Date posted: July 25, 2008 ; Last revised: June 7, 2011

Suggested Citation

Ahoniemi, Katja and Lanne, Markku, Time-Varying Mixture Multiplicative Error Models for Implied Volatility (July 17, 2008). Available at SSRN: http://ssrn.com/abstract=1176203 or http://dx.doi.org/10.2139/ssrn.1176203

Contact Information

Katja Ahoniemi (Contact Author)
Imperial College Business School ( email )
South Kensington Campus
London, SW7 2AZ
United Kingdom
Markku Lanne
University of Helsinki - Department of Political and Economic Studies ( email )
P.O. Box 54
FIN-00014 Helsinki
Finland
+358-9-191 24626 (Phone)
+358-9-191 24780 (Fax)
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