Stochastic Volatility and the Distribution of Exchange Rate News

Posted: 14 Sep 1999

See all articles by Ronald Mahieu

Ronald Mahieu

Tilburg University - Center for Economic Research, Econometrics and Finance Group; TiasNimbas Business School

Peter C. Schotman

Maastricht University - Department of Finance

Date Written: August 1994

Abstract

This paper studies the empirical performance of stochastic volatility models for twenty years of weekly exchange rate data. We concentrate on the effects of the distribution of the exchange rate innovations for parameter estimates and for estimates of the latent volatility series. We approximate the density of the log of exchange rate innovations by a mixture of normals. The major findings of the paper are that: (i) explicitly incorporating fat-tailed innovations increases the estimates of the persistence of volatility dynamics; (ii) estimates of the latent volatility series depend strongly on the estimation technique; (iii) the estimation error of the volatility time series is so large that finance applications to option pricing should be interpreted with care. We reach these conclusions using three different estimation techniques: quasi maximum likelihood, simulated EM, and a Bayesian procedure based on the Gibbs sampler.

JEL Classification: C32, G15

Suggested Citation

Mahieu, Ronald J. and Schotman, Peter C., Stochastic Volatility and the Distribution of Exchange Rate News (August 1994). Available at SSRN: https://ssrn.com/abstract=5598

Ronald J. Mahieu (Contact Author)

Tilburg University - Center for Economic Research, Econometrics and Finance Group ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2430 (Phone)
+31 13 466 3280 (Fax)

HOME PAGE: http://center.uvt.nl/staff/mahieu/

TiasNimbas Business School ( email )

Warandelaan 2
Tilburg, North-Brabant 5071HS
Netherlands

Peter C. Schotman

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

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