Discriminating between GARCH and stochastic volatility via nonnested hypotheses testing
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Date
2013-07-04
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Abstract
GARCH- and Stochastic Volatility (SV)-models are the main workhorses for
describing unobserved volatility in asset returns. Because economic theory
behind these models is not the same and estimating SV-models is much more
difficult, discriminating between these two rival models is of interest. This
paper suggests a nonnested testing procedure going back to Davidson and
MacKinnon (1981) that does not implicitly assume that one of the models is
the correct one. We illustrate the proposed test by applying it to ten daily
stock index return series and five exchange rate return series.
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Keywords
model selection, nonnested testing, stochastic volatility