COMFORT: A Common Market Factor Non-Gaussian Returns Model

28 Pages Posted: 2 Jul 2013 Last revised: 6 Sep 2014

See all articles by Marc S. Paolella

Marc S. Paolella

University of Zurich - Department of Banking and Finance; Swiss Finance Institute

Pawel Polak

University of Zurich; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Date Written: June 18, 2014

Abstract

A new multivariate time series model with various attractive properties is motivated and studied. By extending the CCC model in several ways, it allows for all the primary stylized facts of financial asset returns, including volatility clustering, non-normality (excess kurtosis and asymmetry), and also dynamics in the dependency between assets over time. A fast EM-algorithm is developed for estimation. Each element of the vector return at time t is endowed with a common univariate shock, interpretable as a common market factor. This leads to the new model being a hybrid of GARCH and stochastic volatility, but without the estimation problems associated with the latter, and being applicable in the multivariate setting for potentially large numbers of assets. A feasible technique which allows for multivariate option pricing is presented, along with an empirical illustration.

Keywords: CCC; Common Jumps; Density Forecasting; EM-Algorithm; Fat Tails; GARCH; Multivariate Asymmetric Variance Gamma Distribution; Multivariate Generalized Hyperbolic Distribution; Multivariate Option Pricing; Stochastic Volatility

JEL Classification: C51, C53, G11, G17

Suggested Citation

Paolella, Marc S. and Polak, Pawel, COMFORT: A Common Market Factor Non-Gaussian Returns Model (June 18, 2014). Swiss Finance Institute Research Paper No. 13-38. Available at SSRN: https://ssrn.com/abstract=2287793 or http://dx.doi.org/10.2139/ssrn.2287793

Marc S. Paolella (Contact Author)

University of Zurich - Department of Banking and Finance

Plattenstr. 14
Zürich, 8032
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Pawel Polak

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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