Modelling Volatilities and Conditional Correlations in Futures Markets with a Multivariate T Distribution

41 Pages Posted: 19 Jul 2007

See all articles by Bahram Pesaran

Bahram Pesaran

University of East London - Department of Applied Economics

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

Date Written: July 2007

Abstract

This paper considers a multivariate t version of the Gaussian dynamic conditional correlation (DCC) model proposed by Engle (2002), and suggests the use of devolatized returns computed as returns standardized by realized volatilities rather than by GARCH type volatility estimates. The t-DCC estimation procedure is applied to a portfolio of daily returns on currency futures, government bonds and equity index futures. The results strongly reject the normal-DCC model in favour of a t-DCC specification. The t-DCC model also passes a number of VaR diagnostic tests over an evaluation sample. The estimation results suggest a general trend towards a lower level of return volatility, accompanied by a rising trend in conditional cross correlations in most markets; possibly reflecting the advent of euro in 1999 and increased interdependence of financial markets.

Keywords: volatilities and correlations, futures market, multivariate t, financial interdependence, VaR diagnostics

JEL Classification: C51, C52, G11

Suggested Citation

Pesaran, Bahram and Pesaran, M. Hashem, Modelling Volatilities and Conditional Correlations in Futures Markets with a Multivariate T Distribution (July 2007). IZA Discussion Paper No. 2906, CESifo Working Paper No. 2056, IEPR Working Paper No. 07.19, Available at SSRN: https://ssrn.com/abstract=1000888

Bahram Pesaran

University of East London - Department of Applied Economics ( email )

Longbridge Road
Dagenham, Essex RM8 2AS
United Kingdom
+44 (0)181 590 7000 ex 2123 (Phone)

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

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