A Simplified Approach to Modelling the Co-Movement of Asset Returns

University of Exeter Finance and Investment Working Paper

20 Pages Posted: 14 Jan 2005 Last revised: 29 Apr 2019

See all articles by Richard D. F. Harris

Richard D. F. Harris

University of Bristol, School of Accounting and Finance; University of Bristol, School of Accounting and Finance

Evarist Stoja

University of Bristol

Jon Tucker

Coventry University; UWE Bristol

Date Written: October 1, 2004

Abstract

This paper proposes a simplified multivariate GARCH model that involves the estimation of only univariate GARCH models, both for the individual return series and for the sum and difference of each pair of series. The covariance between each pair of return series is then imputed from these variance estimates. The model that we propose is considerably easier to estimate than existing multivariate GARCH models and does not suffer from the convergence problems that characterize many of these models. Moreover, the model can be easily extended to include more complex dynamics or alternative forms of the GARCH specification. We use the simplified multivariate GARCH model to estimate the minimum-variance hedge ratio for the FTSE 100 index portfolio, hedged using index futures, and compare it to four of the most widely used multivariate GARCH models. The simplified multivariate GARCH model performs at least as well as the other models that we consider, and in some cases better than them.

Keywords: Multivariate GARCH, hedging, minimum-variance hedge ratio, FTSE 100 index

JEL Classification: G11

Suggested Citation

Harris, Richard D. F. and Stoja, Evarist and Tucker, Jon and Tucker, Jon, A Simplified Approach to Modelling the Co-Movement of Asset Returns (October 1, 2004). University of Exeter Finance and Investment Working Paper, Available at SSRN: https://ssrn.com/abstract=606421 or http://dx.doi.org/10.2139/ssrn.606421

University of Bristol, School of Accounting and Finance

United Kingdom

HOME PAGE: http://www.bristol.ac.uk/people/person/Richard-Harris-50ffa5fb-0e86-4458-8e8c-8dace6eb3435/

Evarist Stoja

University of Bristol ( email )

School of Accounting and Finance
8 Woodland Road
Bristol, BS8 1TN
United Kingdom

HOME PAGE: http://sites.google.com/view/evarist-stoja/

Jon Tucker

UWE Bristol ( email )

Frenchay Campus
Coldharbour Lane
Bristol, Avon BS16 1QY
United Kingdom

Coventry University ( email )

Priory Street
Coventry, CV1 5FB
United Kingdom

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