Improving the Asymmetric Stochastic Volatility Model with Ex-post Volatility: The Identification of the Asymmetry

Abstract

Simulation studies prove that the asymmetry stochastic volatility (ASV) models may infer erroneous correlation coefficients, due to their predetermined return-volatility specification. We propose identifying the correlation parameter by incorporating the ex-post volatility in the ASV framework. We obtain a significantly smaller magnitude in the estimated correlation coefficients between equity and volatility processes among major U.S. equity market indexes. Out-of-sample index return distribution forecasts demonstrate superior performance when jointly estimating the return and the ex-post volatility processes. The corrected return-volatility correlations by estimating proposed ASV models with subsample data further document the time-varying leverage effect.

Keywords: Asymmetric Stochastic Volatility, Leverage Effect, Bayesian MCMC, Realized Volatility, Bipower Variation

JEL Classification: C11, C15, C22, C52