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Modeling the Dependence of Conditional Correlations on Market Volatility

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Bauwens, Luc [UCL] Otranto, Edoardo [Univeirsita di Messina]

Several models have been developed to capture the dynamics of the conditional correlations between time series of financial returns and several studies have shown that the market volatility is a major determinant of the correlations. We extend some models to include explicitly the dependence of the correlations on the market volatility. The models differ by the way — linear or nonlinear, direct or indirect — in which the volatility influences the correlations. Using a wide set of models with two measures of market volatility on two datasets, we find that for some models, the empirical results support to some extent the statistical significance and the economic significance of the volatility effect on the correlations, but the presence of the volatility effect does not improve the forecasting performance of the extended models. Supplementary materials for this article are available online.

Document type Article de périodique (Journal article) – Article de recherche
Access type Accès interdit
Publication date 2016
Language Anglais
Journal information "Journal of Business & Economic Statistics" - Vol. 34, p. 254-268 (2016)
Publisher Informa UK Limited
issn 0735-0015
e-issn 1537-2707
Publication status Publié
Affiliation UCL - SSH/LIDAM/CORE - Center for operations research and econometrics
Keywords dynamic conditional correlations ; forecasting ; Markov switching ; minimum variance portfolio ; model confidence set
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Bibliographic reference Bauwens, Luc ; Otranto, Edoardo. Modeling the Dependence of Conditional Correlations on Market Volatility. In: Journal of Business & Economic Statistics, Vol. 34, p. 254-268 (2016)
Permanent URL http://hdl.handle.net/2078.1/190985