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A dynamic conditional score model for the log correlation matrix

Author

Listed:
  • Hafner, Christian M.

    (Université catholique de Louvain, LIDAM/ISBA, Belgium)

  • Wang, Linqi

    (Université catholique de Louvain, LIDAM/LFIN, Belgium)

Abstract
This paper proposes a new model for the dynamics of correlation matrices, where the dynamics are driven by the likelihood score with respect to the matrix logarithm of the correlation matrix. In analogy to the exponential GARCH model for volatility, this transformation ensures that the correlation matrices remain positive definite, even in high dimensions. For the conditional distribution of returns, we assume a student-t copula to explain the dependence structure and univariate student-t for the marginals with potentially different degrees of freedom. The separation into volatility and correlation parts allows for a two-step estimation, which facilitates estimation in high dimensions. We derive estimation theory for one-step and two-step estimation. In an application to a set of six asset indices including financial and alternative assets we show that the model performs well in terms of diagnostics, specification tests, and out-of-sample forecasting.

Suggested Citation

  • Hafner, Christian M. & Wang, Linqi, 2022. "A dynamic conditional score model for the log correlation matrix," LIDAM Reprints LFIN 2022006, Université catholique de Louvain, Louvain Finance (LFIN).
    • Handle: RePEc:ajf:louvlr:2022006
    DOI: https://doi.org/10.1016/j.jeconom.2021.09.004
    Note: In: Journal of Econometrics, 2022
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    Keywords

    Score ; correlation ; matrix logarithm ; identification;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • Z11 - Other Special Topics - - Cultural Economics - - - Economics of the Arts and Literature

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