The realized empirical distribution function of stochastic variance with application to goodness-of-fit testing

Kim Christensen, Martin Thyrsgaard and Bezirgen Veliyev

Journal of Econometrics, 2019, vol. 212, issue 2, 556-583

Abstract: We propose a nonparametric estimator of the empirical distribution function (EDF) of the latent spot variance of the log-price of a financial asset. We show that over a fixed time span our realized EDF (or REDF) – inferred from noisy high-frequency data – is consistent as the mesh of the observation grid goes to zero. In a double-asymptotic framework, with time also increasing to infinity, the REDF converges to the cumulative distribution function of volatility, if it exists. We exploit these results to construct some new goodness-of-fit tests for stochastic volatility models. In a Monte Carlo study, the REDF is found to be accurate over the entire support of volatility. This leads to goodness-of-fit tests that are both correctly sized and relatively powerful against common alternatives. In an empirical application, we recover the REDF from stock market high-frequency data. We inspect the goodness-of-fit of several two-parameter marginal distributions that are inherent in standard stochastic volatility models. The inverse Gaussian offers the best overall description of random equity variation, but the fit is less than perfect. This suggests an extra parameter (as available in, e.g., the generalized inverse Gaussian) is required to model stochastic variance.

Keywords: Empirical processes; Goodness-of-fit; High-frequency data; Microstructure noise; Pre-averaging; Realized variance; Stochastic volatility (search for similar items in EconPapers)
JEL-codes: C10 C50 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Working Paper: The realized empirical distribution function of stochastic variance with application to goodness-of-fit testing (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:212:y:2019:i:2:p:556-583

DOI: 10.1016/j.jeconom.2019.06.002

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