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FRACTIONAL COINTEGRATION IN STOCHASTIC VOLATILITY MODELS

Published online by Cambridge University Press:  11 June 2008

Afonso Gonçalves da Silva  and
Peter M. Robinson
Afonso Gonçalves da Silva*
Affiliation:
London School of Economics and Political Science
Peter M. Robinson
Affiliation:
London School of Economics and Political Science
*
Address correspondence to Afonso Gonçalves da Silva, Concordia Advisors, Unit 112 Harbour Yard, Chelsea Harbour, London SW10 0XD, United Kingdom; e-mail: agsilva@concordiafunds.com
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Abstract

Asset returns are frequently assumed to be determined by one or more common factors. We consider a bivariate factor model where the unobservable common factor and idiosyncratic errors are stationary and serially uncorrelated but have strong dependence in higher moments. Stochastic volatility models for the latent variables are employed, in view of their direct application to asset pricing models. Assuming that the underlying persistence is higher in the factor than in the errors, a fractional cointegrating relationship can be recovered by suitable transformation of the data. We propose a narrow band semiparametric estimate of the factor loadings, which is shown to be consistent with a rate of convergence, and its finite-sample properties are investigated in a Monte Carlo experiment.

Type
Research Article
Information
Econometric Theory , Volume 24 , Issue 5 , October 2008 , pp. 1207 - 1253
Copyright
Copyright © Cambridge University Press 2008

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