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http://ssrn.com/abstract=334040
 
 

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The Common and Specific Components of Dynamic Volatility


Gregory Connor


London School of Economics & Political Science (LSE) - Department of Accounting and Finance

Robert A. Korajczyk


Northwestern University - Kellogg School of Management

Oliver B. Linton


University of Cambridge

July 24, 2003

Northwestern University, Finance Working Paper No. 311

Abstract:     
This paper develops a dynamic approximate factor model in which returns are time-series heteroskedastic. The heteroskedasticity has three components: a factor-related component, a common asset-specific component, and a purely asset-specific component. We develop a new multivariate GARCH model for the factor-related component. We develop a univariate stochastic volatility model linked to a cross-sectional series of individual GARCH models for the common asset-specific component and the purely asset-specific component. We apply the analysis to monthly US equity returns for the period January 1926 to December 2000. We find that all three components contribute to the heteroskedasticity of individual equity returns. Factor volatility and the common component in asset-specific volatility have long-term secular trends as well as short-term autocorrelation. Factor volatility has correlation with interest rates and the business cycle.

Number of Pages in PDF File: 32

Keywords: APT, ARCH, Factor Models, Principal Components, Volatility

JEL Classification: C13, C23, G12

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Date posted: November 3, 2002  

Suggested Citation

Connor, Gregory and Korajczyk, Robert A. and Linton, Oliver B., The Common and Specific Components of Dynamic Volatility (July 24, 2003). Northwestern University, Finance Working Paper No. 311. Available at SSRN: http://ssrn.com/abstract=334040 or http://dx.doi.org/10.2139/ssrn.334040

Contact Information

Gregory Connor (Contact Author)
London School of Economics & Political Science (LSE) - Department of Accounting and Finance ( email )
Houghton Street
London WC2A 2AE
United Kingdom
+44 702 955-6407 (Phone)
+44 702 955-7420 (Fax)
Robert A. Korajczyk
Northwestern University - Kellogg School of Management ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
847-491-8336 (Phone)
847-491-5719 (Fax)
Oliver B. Linton
University of Cambridge ( email )
Faculty of Economics
Cambridge, CB3 9DD
United Kingdom
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