Finite Sample Optimality of Score-Driven Volatility Models

Tinbergen Institute Discussion Paper 17-111/III

23 Pages Posted: 29 Nov 2017

See all articles by Francisco Blasques

Francisco Blasques

VU University Amsterdam; Tinbergen Institute

Andre Lucas

Vrije Universiteit Amsterdam; Tinbergen Institute

Andries van Vlodrop

VU University Amsterdam

Date Written: November 21, 2017

Abstract

We study optimality properties in finite samples for time-varying volatility models driven by the score of the predictive likelihood function. Available optimality results for this class of models suffer from two drawbacks. First, they are only asymptotically valid when evaluated at the pseudo-true parameter. Second, they only provide an optimality result 'on average' and do not provide conditions under which such optimality prevails. We show in a finite sample setting that score-driven volatility models have optimality properties when they matter most. Score-driven models perform best when the data is fat-tailed and robustness is important. Moreover, they perform better when filtered volatilities differ most across alternative models, such as in periods of financial distress. These results are confirmed by an empirical application based on U.S. stock returns.

Keywords: Volatility models, score-driven dynamics, finite samples, Kullback-Leibler divergence, optimality

JEL Classification: C01, C18, C20

Suggested Citation

Blasques, Francisco and Blasques, Francisco and Lucas, Andre and van Vlodrop, Andries, Finite Sample Optimality of Score-Driven Volatility Models (November 21, 2017). Tinbergen Institute Discussion Paper 17-111/III, Available at SSRN: https://ssrn.com/abstract=3076829 or http://dx.doi.org/10.2139/ssrn.3076829

Francisco Blasques (Contact Author)

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Andre Lucas

Vrije Universiteit Amsterdam ( email )

SBE/EDS, De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands
+31 20 598 6039 (Phone)
+31 20 598 6020 (Fax)

HOME PAGE: http://personal.vu.nl/a.lucas

Tinbergen Institute

Roetersstraat 31
Amsterdam, 1018 WB
Netherlands

HOME PAGE: http://www.tinbergen.nl

Andries Van Vlodrop

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

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