Estimating the diffusion coefficient function for a diversified world stock index

  • Authors:

  • Katja Ignatieva;Eckhard Platen

  • Affiliations:

  • Department of Applied Finance and Actuarial Studies, Macquarie University, Eastern Road, North Ryde NSW 2109, Sydney, Australia and Department of Finance, House of Finance, Goethe University Frank ...;School of Finance and Economics and Department of Mathematics, University of Technology Sydney, PO Box 123, Broadway NSW 2007, Sydney, Australia

  • Venue:
  • Computational Statistics & Data Analysis
  • Year:
  • 2012

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Abstract

This paper deals with the estimation of continuous-time diffusion processes which model the dynamics of a well diversified world stock index (WSI). We use the nonparametric kernel-based estimation to empirically identify a square root type diffusion coefficient function in the dynamics of the discounted WSI. A square root process turns out to be an excellent building block for a parsimonious model for the WSI. Its dynamics allow capturing various empirical stylized facts and long term properties of the index, as well as, the explicit computation of various financial quantities.