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Fat-tailed stochastic volatility model and the stock market returns in China

Donglian Ma (Graduate School of Economics, Osaka University, Osaka, Japan)
Hisashi Tanizaki (Graduate School of Economics, Osaka University, Osaka, Japan)

China Finance Review International

ISSN: 2044-1398

Article publication date: 26 June 2019

Issue publication date: 27 April 2021

Abstract

Purpose

The purpose of this paper is to investigate how the selection of return distribution impacts estimated volatility in China’s stock market.

Design/methodology/approach

The authors use a Bayesian analysis of fat-tailed stochastic volatility (SV) model with Student’s t-distribution, and conduct an out-of-sample test with realized volatility.

Findings

Empirical analysis results indicate that fat-tailed SV model performs better in capturing the dynamics of daily returns. The authors find that asymmetry, holiday and day of the week effects are detected in estimated volatility. However, the out-of-sample comparison shows that fat-tailed SV models fail to outperform SV models with normal distribution in fitting and predicting realized volatility.

Originality/value

The contribution of this paper to existing literature is twofold. First, it proves that fat-tailed SV models with Student’s t-distribution perform better than normally distributed SV models in fitting daily returns of China’s stock market. Second, this paper takes asymmetry, holiday and day of the week effects into consideration at the same time in the fat-tailed SV model.

Keywords

Acknowledgements

The authors thank the editor(s) for their valuable time, and they also thank three anonymous reviewers for their constructive comments. The first author acknowledges China Scholarship Council (CSC) for sponsoring the PhD program at Osaka University. This research is supported by the Japan Society for the Promotion of Science, Grant-in-Aid for Scientific Research (C) 17K03657.

Citation

Ma, D. and Tanizaki, H. (2021), "Fat-tailed stochastic volatility model and the stock market returns in China", China Finance Review International, Vol. 11 No. 2, pp. 170-184. https://doi.org/10.1108/CFRI-03-2018-0028

Publisher

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Emerald Publishing Limited

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