Stochastic Volatility Models with Persistent Latent Factors: Theory and Its Applications to Asset Prices

by Lee, Hyoung Il

Abstract (Summary)
We consider the stochastic volatility model with smooth transition and persistent la- tent factors. We argue that this model has advantages over the conventional stochastic model for the persistent volatility factor. Though the linear filtering is widely used in the state space model, the simulation result, as well as theory, shows that it does not work in our model. So we apply the density-based filtering method; in particular, we develop two methods to get solutions. One is the conventional approach using the Maximum Likelihood estimation and the other is the Bayesian approach using Gibbs sampling. We do a simulation study to explore their characteristics, and we apply both methods to actual macroeconomic data to extract the volatility generating process and to compare macro fundamentals with them. Next we extend our model into multivariate model extracting common and id- iosyncratic volatility for multivariate processes. We think it is interesting to apply this multivariate model into measuring time-varying uncertainty of macroeconomic variables and studying the links to market returns via a consumption-based asset pric- ing model. Motivated by Bansal and Yaron (2004), we extract a common volatility factor using consumption and dividend growth, and we find that this factor predicts post-war business cycle recessions quite well. Then, we estimate a long-run risk model of asset prices incorporating this macroeconomic uncertainty. We find that both risk aversion and the intertemporal elasticity of substitution are estimated to be around two, and our simulation results show that the model can match the first and second moments of market return and risk-free rate, hence the equity premium.
Bibliographical Information:

Advisor:Park, Joon Y.; Jansen, Dennis W.; Kim, Hwagyun; Wu, Ximing

School:Texas A&M University

School Location:USA - Texas

Source Type:Master's Thesis

Keywords:stochastic volatility models


Date of Publication:08/01/2008

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