A GARCH model with two volatility components and two driving factors
Abstract
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.
Keywords
Cite
@article{arxiv.2410.14585,
title = {A GARCH model with two volatility components and two driving factors},
author = {Luca Vincenzo Ballestra and Enzo D'Innocenzo and Christian Tezza},
journal= {arXiv preprint arXiv:2410.14585},
year = {2024}
}