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Empirical Analysis of Affine vs. Non-Affine Variance Specifications in Jump-Diffusion Models for Equity Indices

49 Pages Posted: 16 Feb 2009 Last revised: 13 Feb 2015

Katja Ignatieva

University of New South Wales - Australian School of Business

Paulo Rodrigues

Maastricht University - Department of Finance

Norman Seeger

VU University Amsterdam

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Date Written: March 25, 2012

Abstract

How to model the variance process driving stock returns is a major research questions in finance. The specification of a variance model has implications for, e.g., risk management decisions, portfolio allocation or derivative pricing. This paper analyzes several crucial questions for setting up a variance model. (i) Are jumps an important model ingredient even when using a non-affine specification? (ii) How do affine specifications perform when compared to non-affine models. (iii) How should non-linearities be modeled? We find that, first, jump models clearly outperform pure stochastic volatility models. Second, non-affine specifications outperform affine models, even after including jumps. And finally, we find that the polynomial specification of the drift term, that has also been used in short rate models, is the best non-affine model under consideration.

Keywords: Stochastic volatility, Markov Chain Monte Carlo (MCMC), Bayesian inference Deviance information criteria (DIC), Bayes factor

JEL Classification: G11, G12

Suggested Citation

Ignatieva, Katja and Rodrigues, Paulo and Seeger, Norman, Empirical Analysis of Affine vs. Non-Affine Variance Specifications in Jump-Diffusion Models for Equity Indices (March 25, 2012). Seeger, N.J., Rodrigues, P.J.M. & Ignatieva, K. (2015). Empirical Analysis of Affine vs. Nonaffine Variance Specifications in Jump-Diffusion Models for Equity Indices. Journal of Business and Economic Statistics, 33(1), 68-75. 10.1080/07350015.2014.922471. Available at SSRN: https://ssrn.com/abstract=1344226 or http://dx.doi.org/10.2139/ssrn.1344226

Katja Ignatieva

University of New South Wales - Australian School of Business ( email )

Sydney, NSW 2052
Australia

Paulo Rodrigues (Contact Author)

Maastricht University - Department of Finance ( email )

Maastricht, 6200 MD
Netherlands

Norman Seeger

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands
+31 20 598 1512 (Phone)

HOME PAGE: http://www.norman-seeger.com

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