Hierarchical Markov Normal Mixture Models with Applications to Financial Asset Returns

77 Pages Posted: 28 Aug 2007

See all articles by John Geweke

John Geweke

University of Technology Sydney - Economics Discipline Group

Gianni Amisano

Board of Governors of the Federal Reserve System; European Central Bank (ECB); University of Bologna - Rimini Center for Economic Analysis (RCEA); University of Brescia - Department of Economics

Date Written: November 2007

Abstract

With the aim of constructing predictive distributions for daily returns, we introduce a new Markov normal mixture model in which the components are themselves normal mixtures. We derive the restrictions on the autocovariances and linear representation of integer powers of the time series in terms of the number of components in the mixture and the roots of the Markov process. We use the model prior predictive distribution to study its implications for some interesting functions of returns. We apply the model to construct predictive distributions of daily S&P 500 returns, dollar-pound returns, and one- and ten-year bonds. We compare the performance of the model with ARCH and stochastic volatility models using predictive likelihoods. The model's performance is about the same as its competitors for the bond returns, better than its competitors for the S&P 500 returns, and much better for the dollar-pound returns. Validation exercises identify some potential improvements.

Keywords: asset returns, Bayesian, forecasting, MCMC, mixture models

JEL Classification: C53, G12, C11, C14

Suggested Citation

Geweke, John and Amisano, Gianni, Hierarchical Markov Normal Mixture Models with Applications to Financial Asset Returns (November 2007). ECB Working Paper No. 831, Available at SSRN: https://ssrn.com/abstract=1009589 or http://dx.doi.org/10.2139/ssrn.1009589

John Geweke (Contact Author)

University of Technology Sydney - Economics Discipline Group ( email )

645 Harris Street
Sydney, NSW 2007
Australia
0295149797 (Phone)

HOME PAGE: http://www.censoc.uts.edu.au/about/members/jgeweke_papers.html

Gianni Amisano

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

University of Bologna - Rimini Center for Economic Analysis (RCEA) ( email )

Via Patara, 3
Rimini (RN), RN 47900
Italy

University of Brescia - Department of Economics ( email )

Via San Faustino 74B
Brescia, 25122
Italy

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