2024/10/18 by Ballestra, Luca Vincenzo, D'Innocenzo, Enzo, Tezza, Christian
#Econometrics (econ.EM) #FOS: Economics and business
paper · doi:10.48550/arxiv.2410.14585
We introduce a novel GARCH model that integrates two sources of uncertainty to better capture the rich, multi-component dynamics often observed in the volatility of financial assets. This model provides a quasi closed-form representation of the characteristic function for future log-returns, from which semi-analytical formulas for option pricing can be derived. A theoretical analysis is conducted to establish sufficient conditions for strict stationarity and geometric ergodicity, while also obtaining the continuous-time diffusion limit of the model. Empirical evaluations, conducted both in-sample and out-of-sample using S&P500 time series data, show that our model outperforms widely used single-factor models in predicting returns and option prices.