Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/65295
Authors: 
Kleinow, Torsten
Year of Publication: 
2002
Series/Report no.: 
Discussion Papers, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes 2002,38
Abstract: 
In mathematical finance diffusion models are widely used and a variety of different parametric models for the drift and diffusion coefficient coexist in the literature. Since derivative prices depend on the particular parametric model of the diffusion coefficient function of the underlying, a misspecification of this function leads to misspecified option prices. We develop two tests about a parametric form of the diffusion coefficient. The finite sample properties of the tests are investigated in a simulation study and the tests are applied to the 7 -day Eurodollar rate, the German stock market index DAX and five German stocks. For all observed processes, we find in the empirical analysis that our tests reject all tested parametric models. We conclude that affine diffusion processes might not be appropriate to model the evolution of financial time series and that a successful model for a financial market should incorporate the history of the observed processes of additional sources of randomness like stochastic volatility models.
Subjects: 
Diffusion
Continuous-time financial models
Nonparametric methods
Kernel smoothing
Goodness of fit test
spot rate models
interest rate
stock market index
Empirical Likelihood
JEL: 
C12
C14
C22
C52
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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