Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 0652: Modelling Multivariate Autoregressive Conditional Heteroskedasticity with the Double Smooth Transition Conditional Correlation GARCH model

Annastiina Silvennoinen () and Timo Teräsvirta ()
Additional contact information
Annastiina Silvennoinen: School of Finance and Economics, Postal: Queensland University of Technology, Brisbane, Australia
Timo Teräsvirta: CREATES, Postal: University of Aarhus, Building 1322, DK-8000 Aarhus C, Denmark

Abstract: In this paper we propose a multivariate GARCH model with a time-varying conditional correlation structure. The new Double Smooth Transition Conditional Correlation GARCH model extends the Smooth Transition Conditional Correlation GARCH model of Silvennoinen and Teräsvirta (2005) by including another variable according to which the correlations change smoothly between states of constant correlations. A Lagrange multiplier test is derived to test the constancy of correlations against the DSTCC-GARCH model, and another one to test for another transition in the STCC-GARCH framework. In addition, other specification tests, with the aim of aiding the model building procedure, are considered. Analytical expressions for the test statistics and the required derivatives are provided. The model is applied to a selection of world stock indices, and it is found that time is an important factor affecting correlations between them.

Keywords: Multivariate GARCH; Constant conditional correlation; Dynamic conditional correlation; Return comovement; Variable correlation GARCH model; Volatility model evaluation

JEL-codes: C12; C32; C51; C52; G10

28 pages, February 1, 2007

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