Copula-Based Dynamic Conditional Correlation Multiplicative Error Processes

29 Pages Posted: 12 Sep 2012

See all articles by Taras Bodnar

Taras Bodnar

Europa-Universitaet Viadrina

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research; Center for Financial Studies (CFS); Vienna Graduate School of Finance (VGSF)

Date Written: June 15, 2012

Abstract

We introduce a copula-based dynamic model for multivariate processes of (non-negative) high-frequency trading variables revealing time-varying conditional variances and correlations. Modeling the variables' conditional mean processes using a multiplicative error model we map the resulting residuals into a Gaussian domain using a Gaussian copula. Based on high-frequency volatility, cumulative trading volumes, trade counts and market depth of various stocks traded at the NYSE, we show that the proposed copula-based transformation is supported by the data and allows capturing (multivariate) dynamics in higher order moments. The latter are modeled using a DCC-GARCH specification. We suggest estimating the model by composite maximum likelihood which is sufficiently flexible to be applicable in high dimensions. Strong empirical evidence for time-varying conditional (co-)variances in trading processes supports the usefulness of the approach. Taking these higher-order dynamics explicitly into account significantly improves the goodness-of-fit of the multiplicative error model and allows capturing time-varying liquidity risks.

Keywords: multiplicative error model, trading processes, copula, DCC-GARCH, liquidity risk

JEL Classification: C32, C58, C46

Suggested Citation

Bodnar, Taras and Hautsch, Nikolaus, Copula-Based Dynamic Conditional Correlation Multiplicative Error Processes (June 15, 2012). Available at SSRN: https://ssrn.com/abstract=2144741 or http://dx.doi.org/10.2139/ssrn.2144741

Taras Bodnar (Contact Author)

Europa-Universitaet Viadrina ( email )

Grosse Scharrnstr. 59
Frankfurt (Oder), Brandenburg 15230
Germany

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research ( email )

Oskar-Morgenstern-Platz 1
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

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