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203
An empirical investigation of continuoustime equity return models
 Journal of Finance
, 2002
"... This paper extends the class of stochastic volatility diffusions for asset returns to encompass Poisson jumps of timevarying intensity. We find that any reasonably descriptive continuoustime model for equityindex returns must allow for discrete jumps as well as stochastic volatility with a pronou ..."
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Cited by 210 (13 self)
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This paper extends the class of stochastic volatility diffusions for asset returns to encompass Poisson jumps of timevarying intensity. We find that any reasonably descriptive continuoustime model for equityindex returns must allow for discrete jumps as well as stochastic volatility with a pronounced negative relationship between return and volatility innovations. We also find that the dominant empirical characteristics of the return process appear to be priced by the option market. Our analysis indicates a general correspondence between the evidence extracted from daily equityindex returns and the stylized features of the corresponding options market prices. MUCH ASSET AND DERIVATIVE PRICING THEORY is based on diffusion models for primary securities. However, prescriptions for practical applications derived from these models typically produce disappointing results. A possible explanation could be that analytic formulas for pricing and hedging are available for only a limited set of continuoustime representations for asset returns
The CrossSection of Volatility and Expected Returns
 Journal of Finance
, 2006
"... We especially thank an anonymous referee and Rob Stambaugh, the editor, for helpful suggestions that greatly improved the article. Andrew Ang and Bob Hodrick both acknowledge support from the NSF. ..."
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Cited by 192 (9 self)
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We especially thank an anonymous referee and Rob Stambaugh, the editor, for helpful suggestions that greatly improved the article. Andrew Ang and Bob Hodrick both acknowledge support from the NSF.
The Dynamics of Stochastic Volatility: Evidence from Underlying and Option Markets
, 2000
"... This paper proposes and estimates a more general parametric stochastic variance model of equity index returns than has been previously considered using data from both underlying and options markets. The parameters of the model under both the objective and riskneutral measures are estimated simultane ..."
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Cited by 126 (3 self)
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This paper proposes and estimates a more general parametric stochastic variance model of equity index returns than has been previously considered using data from both underlying and options markets. The parameters of the model under both the objective and riskneutral measures are estimated simultaneously. I conclude that the square root stochastic variance model of Heston (1993) and others is incapable of generating realistic returns behavior and find that the data are more accurately represented by a stochastic variance model in the CEV class or a model that allows the price and variance processes to have a timevarying correlation. Specifically, I find that as the level of market variance increases, the volatility of market variance increases rapidly and the correlation between the price and variance processes becomes substantially more negative. The heightened heteroskedasticity in market variance that results generates realistic crash probabilities and dynamics and causes returns to display values of skewness and kurtosis much more consistent with their sample values. While the model dramatically improves the fit of options prices relative to the square root process, it falls short of explaining the implied volatility smile for shortdated options.
Separating microstructure noise from volatility
, 2006
"... There are two variance components embedded in the returns constructed using high frequency asset prices: the timevarying variance of the unobservable efficient returns that would prevail in a frictionless economy and the variance of the equally unobservable microstructure noise. Using sample moment ..."
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Cited by 109 (8 self)
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There are two variance components embedded in the returns constructed using high frequency asset prices: the timevarying variance of the unobservable efficient returns that would prevail in a frictionless economy and the variance of the equally unobservable microstructure noise. Using sample moments of high frequency return data recorded at different frequencies, we provide a simple and robust technique to identify both variance components. In the context of a volatilitytiming trading strategy, we show that careful (optimal) separation of the two volatility components of the observed stock returns yields substantial utility gains.
Exact Simulation of Stochastic Volatility and other
 Affine Jump Diffusion Processes, Working Paper
, 2004
"... The stochastic differential equations for affine jump diffusion models do not yield exact solutions that can be directly simulated. Discretization methods can be used for simulating security prices under these models. However, discretization introduces bias into the simulation results and a large nu ..."
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Cited by 88 (1 self)
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The stochastic differential equations for affine jump diffusion models do not yield exact solutions that can be directly simulated. Discretization methods can be used for simulating security prices under these models. However, discretization introduces bias into the simulation results and a large number of time steps may be needed to reduce the discretization bias to an acceptable level. This paper suggests a method for the exact simulation of the stock price and variance under Heston’s stochastic volatility model and other affine jump diffusion processes. The sample stock price and variance from the exact distribution can then be used to generate an unbiased estimator of the price of a derivative security. We compare our method with the more conventional Euler discretization method and demonstrate the faster convergence rate of the error in our method. Specifically, our method achieves an O(s− 1 2) convergence rate, where s is the total computational budget. The convergence rate for the Euler discretization method is O(s− 1 3) or slower, depending on the model coefficients and option payoff function. Subject Classifications: Simulation, efficiency: exact methods. Finance, asset pricing: computational methods. Acknowledgement: This paper was presented at seminars at Columbia University, the sixth Monte
MICROSTRUCTURE NOISE, REALIZED VARIANCE, AND OPTIMAL SAMPLING
, 2005
"... Observed asset prices are known to deviate from their efficient values due to market microstructure frictions. This paper studies the effects of market microstructure noise on nonparametric estimates of the efficient price integrated variance. Specifically, we consider both asymptotic and finite sam ..."
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Cited by 84 (9 self)
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Observed asset prices are known to deviate from their efficient values due to market microstructure frictions. This paper studies the effects of market microstructure noise on nonparametric estimates of the efficient price integrated variance. Specifically, we consider both asymptotic and finite sample effects of general market microstructure noise on realized variance estimates. The finite sample results culminate in a variance/bias tradeoff that serves as a basis for an optimal sampling theory. Our theory also considers the effects of prefiltering the data and proposes a novel biascorrection. We show that this theory is easily implementable in practise requiring only the calculation of sample moments of the observable highfrequency return data.
The Statistical and Economic Role of Jumps in ContinuousTime Interest Rate Models
 Journal of Finance
, 2004
"... This paper provides an empirical analysis of the role of jumps in continuoustime models of the short rate. Statistically, if jumps are present di¤usion models are misspeci…ed and I develop a test to detect jumpinduced misspeci…cation. After …nding evidence for jumps, I introduce a nonparametric ju ..."
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Cited by 62 (0 self)
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This paper provides an empirical analysis of the role of jumps in continuoustime models of the short rate. Statistically, if jumps are present di¤usion models are misspeci…ed and I develop a test to detect jumpinduced misspeci…cation. After …nding evidence for jumps, I introduce a nonparametric jumpdi¤usion model and develop an estimation methodology. The results point toward a dominant statistical role for jumps in determining the dynamics of the short rate relative to di¤usive components. Estimates of jump times and sizes indicate that jumps serve an interesting economic purpose: they provide a main conduit for information about the macroeconomy to enter the term structure. Finally, I investigate the pricing implications of jumps. While jumps do not appear to have a large impact on the crosssection of bond prices, they do have important implications for interest rate derivatives.
Jumps in financial markets: A new nonparametric test and jump clustering
, 2007
"... This article introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intraday level. We demonstrate that the likelihood of misclassification of jumps becomes negligible when we use highfrequency returns. Using our test, we examine jump dyn ..."
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Cited by 57 (3 self)
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This article introduces a new nonparametric test to detect jump arrival times and realized jump sizes in asset prices up to the intraday level. We demonstrate that the likelihood of misclassification of jumps becomes negligible when we use highfrequency returns. Using our test, we examine jump dynamics and their distributions in the U.S. equity markets. The results show that individual stock jumps are associated with prescheduled earnings announcements and other companyspecific news events. Additionally, S&P 500 Index jumps are associated with general market news announcements. This suggests different pricing models for individual equity options versus index options. (JEL G12, G22, G14) Financial markets sometimes generate significant discontinuities, socalled jumps, in financial variables. A number of recent empirical and theoretical studies proved the existence of jumps and their substantial impact on financial management, from portfolio and risk management to option and bond pricing
News Arrival, Jump Dynamics, and Volatility Components for Individual Stock Returns
, 2003
"... This paper models components of the return distribution, which are assumed to be directed by a latent news process. The conditional variance of returns is a combination of jumps and smoothly changing components. A heterogeneous Poisson process with a timevarying conditional intensity parameter gove ..."
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Cited by 57 (3 self)
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This paper models components of the return distribution, which are assumed to be directed by a latent news process. The conditional variance of returns is a combination of jumps and smoothly changing components. A heterogeneous Poisson process with a timevarying conditional intensity parameter governs the likelihood of jumps. Unlike typical jump models with stochastic volatility, previous realizations of both jump and normal innovations can feed back asymmetrically into expected volatility. This model improves forecasts of volatility, particularly after large changes in stock returns. We provide empirical evidence of the impact and feedback effects of jump versus normal return innovations, leverage effects, and the timeseries dynamics of jump clustering. THERE IS A WIDESPREAD PERCEPTION in the financial press that volatility of asset returns has been changing. The new economy is introducing more uncertainty. Indeed, it can be argued that volatility is being transferred from the economy at large into the financial markets, which bear the necessary adjustment shocks. 1
Crises and recoveries in an empirical model of consumption disasters. Working Paper 15920
, 2010
"... We estimate an empirical model of consumption disasters using a new panel data set on consumption for 24 countries and more than 100 years. The model allows for permanent and transitory effects of disasters that unfold over multiple years. It also allows the timing of disasters to be correlated acro ..."
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Cited by 54 (2 self)
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We estimate an empirical model of consumption disasters using a new panel data set on consumption for 24 countries and more than 100 years. The model allows for permanent and transitory effects of disasters that unfold over multiple years. It also allows the timing of disasters to be correlated across countries. We estimate the model using Bayesian methods. Our estimates imply that the average length of disasters is roughly 5 years and that more than half of the short run impact of disasters on consumption are reversed in the long run on average. We investigate the asset pricing implications of these rare disasters. In a model with power utility and standard values for risk aversion, stocks surge at the onset of a disaster due to agents ’ strong desire to save. This causes a low equity premium, especially in normal times. In contrast, a model with EpsteinZinWeil preferences and an intertemporal elasticity of substitution equal to 2 yields a sizeable equity premium in normal times for modest values of risk aversion.