This paper is concerned with the specification for modelling financial leverage effect in the context of stochastic volatility (SV) models. Two alternative specifications co-exist in the literature. One is the Euler approximation to the well-known continuous time SV model with leverage effect and the other is the discrete time SV model of Jacquier et al. (J. Econometrics 122 (2004) 185). Using a Gaussian nonlinear state space form with uncorrelated measurement and transition errors, I show that it is easy to interpret the leverage effect in the conventional model whereas it is not clear how to obtain and interpret the leverage effect in the model of Jacquier et al. Empirical comparisons of these two models via Bayesian Markov chain Monte Carlo (MCMC) methods further reveal that the specification of Jacquier et al. is inferior. Simulation experiments are conducted to study the sampling properties of Bayes MCMC for the conventional model.
Bayes factors; Leverage effect; Markov chain Monte Carlo; Nonlinear state space models; Quasi maximum likelihood; Particle filter
Journal of Econometrics
On Leverage in a Stochastic Volatility Model. (2005). Journal of Econometrics. 127, (2), 165-178. Research Collection School Of Economics.
Available at: http://ink.library.smu.edu.sg/soe_research/276
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