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10

Interest rates in general are far from independent and identically distributed. A high interest rate observation is quite likely to be followed by another high observation, and the volatility is likely to be higher as well. Interest rates are also mean reverting, as in most real-world situations (at least for developed markets) interest rates rarely rise ...


10

There are a number of different tests that are generally used to compare samples to different distributions, such as Jarque-Bera, Anderson-Darling, and Kolmogorov–Smirnov (see this related question). In your case, with just the standard deviation and mean, there isn't a whole lot to say. You need to assume a distribution (e.g. normal). You would be able ...


9

You can directly imply a probability distribution from a volatility skew. Note that, for any terminal probability distribution $p(S)$ at tenor $T$, we have the model-free formula for the call price $C(K)$ as a function of strike $K$ \begin{equation} C=e^{-rT} \int_0^\infty (S-K)^+ p(S) dS \end{equation} Therefore we can write \begin{equation} e^{rT} ...


6

What you refer to as the 99.5th percentile is known as the "Value-at-Risk." You are correct that you will need to make a distributional assumption, and there is a popular and well-researched approach to this problem, though I'm not certain it could be called "standard." I would recommend you use the "truncated Levy flight" distribution. James Xiong at ...


5

Be careful, remember that the mean and the standard deviation don't tell you the whole story: http://en.wikipedia.org/wiki/Anscombe%27s_quartet


4

I think an extremely interesting strand of research on this topic is represented by extensions of vine copulas with time-varying parameters. For vine copulas in general have a look at this site from the Technische Universität München: Vine Copula Models One of their research projects, which is the most relevant in this context, is:Time varying vine copula ...


4

That can be a somewhat difficult question to answer, given that the context may yield different distributions. Nevertheless, I think that you could try to fit the best distribution algorithmically. For instance, lately I found this package at Matlab file exchange: Finding the best distribution that fits the data Link (...) This is where Mike's ...


4

These returns are almost always modeled by finding some fundamental two-sided variable and modeling that. For options, we would model their prices as derivatives -- we would take the log-returns of underlying prices as the fundamental variable, possibly with other models for what would happen to volatilities and the like, and compute the consequences for ...


3

You could try using the Gaussian Affine Term Structure Models (GATSM), with the right boundary conditions to stop rates being negative (in the style of their Black implementation). See, for example, Monika Piazzesi, the "Affine Term Structure Models" if you want to enter/modify the basis or the work of Krippner, for example "Measuring the stance of monetary ...


3

Maybe this could also be a comment but I think an it is not possible to answer this question with a 'yes and here is how you do it'. It has been tried, e.g. by me for a university research project. In this research we focused primarily on aggregation of returns and the main problem was the tractability of the resulting distributions and expressions, also ...


3

It's not possible with a simple linear transformation like the one you mentioned: since scale and thus the distance between mean and median are required to change, either the mean or the median will not be preserved. Therefore you must use nonlinear transformations, which will complicate quite a bit mantaining skew and kurtosis and imho will not be ...


3

the risk neutral drift is needed for pricing of derivatives. For a $100\%$ equity portfolio you can take the real world drift - sometimes a good guess is a drift of zero. For fixed-income you could do the same and might need more sophistication for the variance term. If you have short-dated bonds then you will need a special model for the pull-to-par. For ...


3

Exponential distribution, although it's a good distribution for modeling non-negative numbers, doesn't make sense here since it's mode is 0. From a pure statistical point of view, without any knowledge of interest rate, I'd recommend log-normal as in modeling stock prices and inverse-gamma or gamma distribution which are used to model variance or other ...


3

The pdfs of Student-t distributions have asymptotically Paretian tails, and the tail shape parameter (aka the maximal moment exponent) is equal to the distribution's degrees of freedom parameter. Assuming you have enough observations, you could estimate the Pareto parameter using the so-called Hill method (named after Bruce Hill, 1975). A word of caution: ...


2

Once we start building time-varying copulas like Lopes suggests in that paper, I think we are better off venturing into the world of state space models. When viewed in a bayesian context, the similarities between the approaches are striking to me. The advantage of the copula, as I understand it, is that it is a quick and dirty way to understand the ...


2

Your question is interesting because I thought that the only chance with Lévy-processes is to use Fourier-transform approaches (see e.g. Cont,Tankov). But in the paper Option Pricing for Log-Symmetric Distributions of Returns by Fima C. Klebaner· Zinoviy Landsman they consider models, where the log of the price has a symmetric distribution. In Corollary 3.2 ...


2

By accident i stumbled upon a new work submitted yesterday (http://arxiv.org/abs/1208.5896). It seems most papers are talking about a specific dataset following Benfords law. But that seems not to be what you are looking for. You should look into this bibliography here ( about Benford's law in general): http://arxiv.org/abs/math/0607168 There are also ...


2

It could be much more simple: if you use the method of moments (MM) then you estimate the mean and the variance and for example the kurtosis of your sample. Then you fit the parameters to these statistics. Alternatively you use maximum-likelihood (MLE). For MM: from wikipedia you get the mean and the variance. In your notation you can fit $b = \bar{r}$ so ...


2

The consensus nowadays is that stable distributions are not a well fit, although they do possess heavy tails. In particular Cauchy has too fat tails. The reasons for this are disparate, however the first that comes to mind is that empirically longer horizons show a decrease in tail thickness, approaching normality for 1-year returns (although this has been ...


2

I think modelling hedge fund returns is a very interesting yet demanding task. Your model will have to strike a balance between the tangibility of the model on the one hand and the possibility of parameter estimation on the other. Plus I think you will encounter hedge funds that resist all modelling attempts because there strategies are just too elusive. ...


1

If you mean by fat tails just fatter tails than the gaussian distribtuion, i.e. a distribution with finite variance, for instance the Student's t-distribution has fatter tails than the normal distribution. If you mean distributions with infinite variance, you have to have a look at Lévy distribution. In a first attempt you could just substitute the standard ...


1

I think there are 2 approaches being a bit mixed up here. You can analyze the option market by looking at implied volatilities and apply Black-Scholes (BS), thus assuming that log-returns follow a Gaussian distribution. Implied volatilies are the parameters that bring together BS and market prices. Then you will observe a pattern of implied volatilies for ...


1

I have not tried it myself but if i may be allowed to forward you to a link of a particular filter sold as an indicator called the Jurik MA. If you check the link, there is a quote where they mention ` What we mean by a random walk is a time series produced by a cumulative sum of 5000 zero-mean, Cauchy distributed random numbers.` Also this is supposed to ...


1

In my experience with forecasting, you could try a model of the form $$ X_ t = cycle_t + seasonality_t + residuum_t. $$ Sometimes it is hard to find the cycle but the seasonality could be doable if it has some natural structure (something happening in a certain month each year e.g.). Rob Hyndman explains all these things (and provides an R package) in his ...


1

As Quartz says it is possible to make non-linear transformations taking into account skew and kurtosis, but this is mostly is limited to univariate processes (one approach for a t distribution is to match moments). For multivariate processes, it is considerably more difficult. A more general solution is to rely on Entropy Pooling. You could take views on ...


1

The standard answer to your question would be to do the maximum likelihood estimation. When you say "plug in $\sigma$" you can show that the sample estimate of $\sigma$ is actually the maximum likelihood estimate of $\sigma$ for the normal distribution. If I can assume that your data are IID then what you do is use your distribution with parameters ...


1

Hey I fit GARCH models for the estimation of volatility to forecast VaR, I suggest you use the rugarch package in R.


1

I think the best answer is to test different distributions with your specific data set and see which fits the data the best... skewness and kurtosis are just a small piece of information , there is still a good deal of information we don't know and won't have with out having the data set in front of us


1

General rate trading wisdom shows that if anything, normal distribution fits developed markets better. For example, most swaption traders talk about implied volatilities in basis points (per day or annualized).


1

I have written R code for some time-varying bivariate fat-tailed copula functions (ripped off Patton's Matlab code) and played around with various optimizers. You can then use Rsolnp, nloptr, alabama or DEoptim packages to find an optimisation solution. Here is some R code where I play around with different optimisation algorithms. Note that the data2.csv ...



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