Realized Jumps on Financial Markets and Predicting Credit Spreads

44 Pages Posted: 23 Mar 2007 Last revised: 25 Sep 2008

See all articles by George Tauchen

George Tauchen

Duke University - Economics Group

Hao Zhou

Tsinghua University - PBC School of Finance; SUSTech Business School

Date Written: August 1, 2006

Abstract

This paper extends the jump detection method based on bipower variation to identify realized jumps on financial markets and to estimate parametrically the jump intensity, mean, and variance. Finite sample evidence suggests that the jump parameters can be accurately estimated and that the statistical inferences are reliable under the assumption that jumps are rare and large. Applications to equity market, treasury bond, and exchange rate data reveal important differences in jump frequencies and volatilities across asset classes over time. For investment grade bond spread indices, the estimated jump volatility has more forecasting power than interest rate factors and volatility factors including option-implied volatility, with control for systematic risk factors. The jump volatility risk factor seems to capture the low frequency movements in credit spreads and comoves counter cyclically with the price-dividend ratio and corporate default rate.

Keywords: Jump-Diffusion Process, Realized Variance, Bi-Power Variation, Realized Jumps, Jump Volatility, Credit Risk Premium.

JEL Classification: C22, G13, G14.

Suggested Citation

Tauchen, George E. and Zhou, Hao, Realized Jumps on Financial Markets and Predicting Credit Spreads (August 1, 2006). FEDS Working Paper No. 2006-35, Journal of Econometrics, Forthcoming, Economic Research Initiatives at Duke (ERID) Working Paper No. 7, AFA 2008 New Orleans Meetings Paper, Available at SSRN: https://ssrn.com/abstract=920773 or http://dx.doi.org/10.2139/ssrn.920773

George E. Tauchen

Duke University - Economics Group ( email )

Box 90097
221 Social Sciences
Durham, NC 27708-0097
United States
919-660-1812 (Phone)
919-684-8974 (Fax)

Hao Zhou (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing, 100083
China
+86-10-62790655 (Phone)

SUSTech Business School ( email )

1088 Xueyuan Avenue, Nanshan District
Southern University of Science and Technology
Shenzhen, Guangdong 518055
China

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