Empirical Analysis of Affine vs. Non-Affine Variance Specifications in Jump-Diffusion Models for Equity Indices

Download or read book Empirical Analysis of Affine vs. Non-Affine Variance Specifications in Jump-Diffusion Models for Equity Indices written by Katja Ignatieva and published by . This book was released on 2015 with total page 49 pages. Available in PDF, EPUB and Kindle. Book excerpt: How to model the variance process driving stock returns is a major research questions in finance. The specification of a variance model has implications for, e.g., risk management decisions, portfolio allocation or derivative pricing. This paper analyzes several crucial questions for setting up a variance model. (i) Are jumps an important model ingredient even when using a non-affine specification? (ii) How do affine specifications perform when compared to non-affine models. (iii) How should non-linearities be modeled? We find that, first, jump models clearly outperform pure stochastic volatility models. Second, non-affine specifications outperform affine models, even after including jumps. And finally, we find that the polynomial specification of the drift term, that has also been used in short rate models, is the best non-affine model under consideration.