Extreme Value Theory versus traditional GARCH approaches applied to financial data: a comparative evaluation

Although stock prices fluctuate, the variations are relatively small and are frequently assumed to be normal distributed on a large time scale. But sometimes these fluctuations can become determinant, especially when unforeseen large drops in asset prices are observed that could result in huge losses or even in market crashes. The evidence shows that these events happen far more often than would be expected under the generalized assumption of normal distributed financial returns. Thus it is crucial to properly model the distribution tails so as to be able to predict the frequency and magnitude of extreme stock price returns. In this paper we follow the approach suggested by McNeil and Frey (2000) and combine the GARCH-type models with the Extreme Value Theory (EVT) to estimate the tails of three financial index returns DJI,FTSE 100 and NIKKEI 225 representing three important financial areas in the world. Our results indicate that EVT-based conditional quantile estimates are much more accurate than those from conventional AR-GARCH models assuming normal or Student’s t-distribution innovations when doing out-of-sample estimation (within the insample estimation, this is so for the right tail of the distribution of returns).

On Estimation and Testing for Pareto Tails

2010 Mathematics Subject Classification: 62F10, 62F12.

Estimation of jump-diffusion processes via empirical characteristic functions

Preface The starting point for this work and eventually the subject of the whole thesis was the question: how to estimate parameters of the affine stochastic volatility jump-diffusion models. These models are very important for contingent claim pricing. Their major advantage, availability T of analytical solutions for characteristic functions, made them the models of choice for many theoretical constructions and practical applications. At the same time, estimation of parameters of stochastic volatility jump-diffusion models is not a straightforward task. The problem is coming from the variance process, which is non-observable. There are several estimation methodologies that deal with estimation problems of latent variables. One appeared to be particularly interesting. It proposes the estimator that in contrast to the other methods requires neither discretization nor simulation of the process: the Continuous Empirical Characteristic function estimator (EGF) based on the unconditional characteristic function. However, the procedure was derived only for the stochastic volatility models without jumps. Thus, it has become the subject of my research. This thesis consists of three parts. Each one is written as independent and self contained article. At the same time, questions that are answered by the second and third parts of this Work arise naturally from the issues investigated and results obtained in the first one. The first chapter is the theoretical foundation of the thesis. It proposes an estimation procedure for the stochastic volatility models with jumps both in the asset price and variance processes. The estimation procedure is based on the joint unconditional characteristic function for the stochastic process. The major analytical result of this part as well as of the whole thesis is the closed form expression for the joint unconditional characteristic function for the stochastic volatility jump-diffusion models. The empirical part of the chapter suggests that besides a stochastic volatility, jumps both in the mean and the volatility equation are relevant for modelling returns of the S&P500 index, which has been chosen as a general representative of the stock asset class. Hence, the next question is: what jump process to use to model returns of the S&P500. The decision about the jump process in the framework of the affine jump- diffusion models boils down to defining the intensity of the compound Poisson process, a constant or some function of state variables, and to choosing the distribution of the jump size. While the jump in the variance process is usually assumed to be exponential, there are at least three distributions of the jump size which are currently used for the asset log-prices: normal, exponential and double exponential. The second part of this thesis shows that normal jumps in the asset log-returns should be used if we are to model S&P500 index by a stochastic volatility jump-diffusion model. This is a surprising result. Exponential distribution has fatter tails and for this reason either exponential or double exponential jump size was expected to provide the best it of the stochastic volatility jump-diffusion models to the data. The idea of testing the efficiency of the Continuous ECF estimator on the simulated data has already appeared when the first estimation results of the first chapter were obtained. In the absence of a benchmark or any ground for comparison it is unreasonable to be sure that our parameter estimates and the true parameters of the models coincide. The conclusion of the second chapter provides one more reason to do that kind of test. Thus, the third part of this thesis concentrates on the estimation of parameters of stochastic volatility jump- diffusion models on the basis of the asset price time-series simulated from various "true" parameter sets. The goal is to show that the Continuous ECF estimator based on the joint unconditional characteristic function is capable of finding the true parameters. And, the third chapter proves that our estimator indeed has the ability to do so. Once it is clear that the Continuous ECF estimator based on the unconditional characteristic function is working, the next question does not wait to appear. The question is whether the computation effort can be reduced without affecting the efficiency of the estimator, or whether the efficiency of the estimator can be improved without dramatically increasing the computational burden. The efficiency of the Continuous ECF estimator depends on the number of dimensions of the joint unconditional characteristic function which is used for its construction. Theoretically, the more dimensions there are, the more efficient is the estimation procedure. In practice, however, this relationship is not so straightforward due to the increasing computational difficulties. The second chapter, for example, in addition to the choice of the jump process, discusses the possibility of using the marginal, i.e. one-dimensional, unconditional characteristic function in the estimation instead of the joint, bi-dimensional, unconditional characteristic function. As result, the preference for one or the other depends on the model to be estimated. Thus, the computational effort can be reduced in some cases without affecting the efficiency of the estimator. The improvement of the estimator s efficiency by increasing its dimensionality faces more difficulties. The third chapter of this thesis, in addition to what was discussed above, compares the performance of the estimators with bi- and three-dimensional unconditional characteristic functions on the simulated data. It shows that the theoretical efficiency of the Continuous ECF estimator based on the three-dimensional unconditional characteristic function is not attainable in practice, at least for the moment, due to the limitations on the computer power and optimization toolboxes available to the general public. Thus, the Continuous ECF estimator based on the joint, bi-dimensional, unconditional characteristic function has all the reasons to exist and to be used for the estimation of parameters of the stochastic volatility jump-diffusion models.

Portfolio efficiency tests with conditioning information using empirical likelihood estimation

We evaluate the use of Generalized Empirical Likelihood (GEL) estimators in portfolios efficiency tests for asset pricing models in the presence of conditional information. Estimators from GEL family presents some optimal statistical properties, such as robustness to misspecification and better properties in finite samples. Unlike GMM, the bias for GEL estimators do not increase as more moment conditions are included, which is expected in conditional efficiency analysis. We found some evidences that estimators from GEL class really performs differently in small samples, where efficiency tests using GEL generate lower estimates compared to tests using the standard approach with GMM. With Monte Carlo experiments we see that GEL has better performance when distortions are present in data, especially under heavy tails and Gaussian shocks.

The transform likelihood ratio method for rare event simulation with heavy tails

We present a novel method, called the transform likelihood ratio (TLR) method, for estimation of rare event probabilities with heavy-tailed distributions. Via a simple transformation ( change of variables) technique the TLR method reduces the original rare event probability estimation with heavy tail distributions to an equivalent one with light tail distributions. Once this transformation has been established we estimate the rare event probability via importance sampling, using the classical exponential change of measure or the standard likelihood ratio change of measure. In the latter case the importance sampling distribution is chosen from the same parametric family as the transformed distribution. We estimate the optimal parameter vector of the importance sampling distribution using the cross-entropy method. We prove the polynomial complexity of the TLR method for certain heavy-tailed models and demonstrate numerically its high efficiency for various heavy-tailed models previously thought to be intractable. We also show that the TLR method can be viewed as a universal tool in the sense that not only it provides a unified view for heavy-tailed simulation but also can be efficiently used in simulation with light-tailed distributions. We present extensive simulation results which support the efficiency of the TLR method.

Improved algorithms for rare event simulation with heavy tails

The estimation of P(S-n > u) by simulation, where S, is the sum of independent. identically distributed random varibles Y-1,..., Y-n, is of importance in many applications. We propose two simulation estimators based upon the identity P(S-n > u) = nP(S, > u, M-n = Y-n), where M-n = max(Y-1,..., Y-n). One estimator uses importance sampling (for Y-n only), and the other uses conditional Monte Carlo conditioning upon Y1,..., Yn-1. Properties of the relative error of the estimators are derived and a numerical study given in terms of the M/G/1 queue in which n is replaced by an independent geometric random variable N. The conclusion is that the new estimators compare extremely favorably with previous ones. In particular, the conditional Monte Carlo estimator is the first heavy-tailed example of an estimator with bounded relative error. Further improvements are obtained in the random-N case, by incorporating control variates and stratification techniques into the new estimation procedures.

SEMIPARAMETRIC METHODS IN THE ESTIMATION OF TAIL PROBABILITIES AND EXTREME QUANTILES

In quantitative risk analysis, the problem of estimating small threshold exceedance probabilities and extreme quantiles arise ubiquitously in bio-surveillance, economics, natural disaster insurance actuary, quality control schemes, etc. A useful way to make an assessment of extreme events is to estimate the probabilities of exceeding large threshold values and extreme quantiles judged by interested authorities. Such information regarding extremes serves as essential guidance to interested authorities in decision making processes. However, in such a context, data are usually skewed in nature, and the rarity of exceedance of large threshold implies large fluctuations in the distribution's upper tail, precisely where the accuracy is desired mostly. Extreme Value Theory (EVT) is a branch of statistics that characterizes the behavior of upper or lower tails of probability distributions. However, existing methods in EVT for the estimation of small threshold exceedance probabilities and extreme quantiles often lead to poor predictive performance in cases where the underlying sample is not large enough or does not contain values in the distribution's tail. In this dissertation, we shall be concerned with an out of sample semiparametric (SP) method for the estimation of small threshold probabilities and extreme quantiles. The proposed SP method for interval estimation calls for the fusion or integration of a given data sample with external computer generated independent samples. Since more data are used, real as well as artificial, under certain conditions the method produces relatively short yet reliable confidence intervals for small exceedance probabilities and extreme quantiles.

Scaphoid Fracture Nonunion: Correlation Of Radiographic Imaging, Proximal Fragment Histologic Viability Evaluation, And Estimation Of Viability At Surgery: Diagnosis Of Scaphoid Pseudarthrosis.

The purpose of this study was to correlate the pre-operative imaging, vascularity of the proximal pole, and histology of the proximal pole bone of established scaphoid fracture non-union. This was a prospective non-controlled experimental study. Patients were evaluated pre-operatively for necrosis of the proximal scaphoid fragment by radiography, computed tomography (CT) and magnetic resonance imaging (MRI). Vascular status of the proximal scaphoid was determined intra-operatively, demonstrating the presence or absence of puncate bone bleeding. Samples were harvested from the proximal scaphoid fragment and sent for pathological examination. We determined the association between the imaging and intra-operative examination and histological findings. We evaluated 19 male patients diagnosed with scaphoid nonunion. CT evaluation showed no correlation to scaphoid proximal fragment necrosis. MRI showed marked low signal intensity on T1-weighted images that confirmed the histological diagnosis of necrosis in the proximal scaphoid fragment in all patients. Intra-operative assessment showed that 90% of bones had absence of intra-operative puncate bone bleeding, which was confirmed necrosis by microscopic examination. In scaphoid nonunion MRI images with marked low signal intensity on T1-weighted images and the absence of intra-operative puncate bone bleeding are strong indicatives of osteonecrosis of the proximal fragment.

PENCALC: a program for penetrance estimation in autosomal dominant diseases

We present a computer program developed for estimating penetrance rates in autosomal dominant diseases by means of family kinship and phenotype information contained within the pedigrees. The program also determines the exact 95% credibility interval for the penetrance estimate. Both executable (PenCalc for Windows) and web versions (PenCalcWeb) of the software are available. The web version enables further calculations, such as heterozygosity probabilities and assessment of offspring risks for all individuals in the pedigrees. Both programs can be accessed and down-loaded freely at the home-page address http://www.ib.usp.br/~otto/software.htm.

Load Ratio Estimation Through Striation Height and Spacing Analysis of an Aerospace Al Alloy 7475-T7351

It is well known that striation spacing may be related to the crack growth rate, da/dN, through Paris equation, as well as the maximum and minimum loads under service loading conditions. These loads define the load ratio, R, and are considered impossible to be evaluated from the inter-spacing striations analysis. In this way, this study discusses the methodology proposed by Furukawa to evaluate the maximum and minimum loads based on the experimental fact that the relative height of a striation, H, and the striation spacing, s, are strongly influenced by the load ratio, R. Fatigue tests in C(T) specimens were conducted on SAE 7475-T7351 Al alloy plates at room temperature and the results showed a straightforward correlation between the parameters H, s, and R. Measurements of striation height, H, were performed using scanning electron microscopy and field emission gun (FEG) after sectioning the specimen at a large inclined angle to amplify the height of the striations. The results showed that for increasing R the values of H/s tend to increase. Striation height, striation spacing, and load ratio correlations were obtained, which allows one to estimate service loadings from fatigue fracture surface survey.

Estimation and prediction of parameters and breeding values in soybean using REML/BLUP and Least Squares

The aim of this study was to compare REML/BLUP and Least Square procedures in the prediction and estimation of genetic parameters and breeding values in soybean progenies. F(2:3) and F(4:5) progenies were evaluated in the 2005/06 growing season and the F(2:4) and F(4:6) generations derived thereof were evaluated in 2006/07. These progenies were originated from two semi-early, experimental lines that differ in grain yield. The experiments were conducted in a lattice design and plots consisted of a 2 m row, spaced 0.5 m apart. The trait grain yield per plot was evaluated. It was observed that early selection is more efficient for the discrimination of the best lines from the F(4) generation onwards. No practical differences were observed between the least square and REML/BLUP procedures in the case of the models and simplifications for REML/BLUP used here.

Continental passive microwave-based rainfall estimation algorithm: Application to the Amazon Basin

This paper presents a new statistical algorithm to estimate rainfall over the Amazon Basin region using the Tropical Rainfall Measuring Mission (TRMM) Microwave Imager (TMI). The algorithm relies on empirical relationships derived for different raining-type systems between coincident measurements of surface rainfall rate and 85-GHz polarization-corrected brightness temperature as observed by the precipitation radar (PR) and TMI on board the TRMM satellite. The scheme includes rain/no-rain area delineation (screening) and system-type classification routines for rain retrieval. The algorithm is validated against independent measurements of the TRMM-PR and S-band dual-polarization Doppler radar (S-Pol) surface rainfall data for two different periods. Moreover, the performance of this rainfall estimation technique is evaluated against well-known methods, namely, the TRMM-2A12 [ the Goddard profiling algorithm (GPROF)], the Goddard scattering algorithm (GSCAT), and the National Environmental Satellite, Data, and Information Service (NESDIS) algorithms. The proposed algorithm shows a normalized bias of approximately 23% for both PR and S-Pol ground truth datasets and a mean error of 0.244 mm h(-1) ( PR) and -0.157 mm h(-1)(S-Pol). For rain volume estimates using PR as reference, a correlation coefficient of 0.939 and a normalized bias of 0.039 were found. With respect to rainfall distributions and rain area comparisons, the results showed that the formulation proposed is efficient and compatible with the physics and dynamics of the observed systems over the area of interest. The performance of the other algorithms showed that GSCAT presented low normalized bias for rain areas and rain volume [0.346 ( PR) and 0.361 (S-Pol)], and GPROF showed rainfall distribution similar to that of the PR and S-Pol but with a bimodal distribution. Last, the five algorithms were evaluated during the TRMM-Large-Scale Biosphere-Atmosphere Experiment in Amazonia (LBA) 1999 field campaign to verify the precipitation characteristics observed during the easterly and westerly Amazon wind flow regimes. The proposed algorithm presented a cumulative rainfall distribution similar to the observations during the easterly regime, but it underestimated for the westerly period for rainfall rates above 5 mm h(-1). NESDIS(1) overestimated for both wind regimes but presented the best westerly representation. NESDIS(2), GSCAT, and GPROF underestimated in both regimes, but GPROF was closer to the observations during the easterly flow.

Chain motifs: The tails and handles of complex networks

A great part of the interest in complex networks has been motivated by the presence of structured, frequently nonuniform, connectivity. Because diverse connectivity patterns tend to result in distinct network dynamics, and also because they provide the means to identify and classify several types of complex network, it becomes important to obtain meaningful measurements of the local network topology. In addition to traditional features such as the node degree, clustering coefficient, and shortest path, motifs have been introduced in the literature in order to provide complementary descriptions of the network connectivity. The current work proposes a different type of motif, namely, chains of nodes, that is, sequences of connected nodes with degree 2. These chains have been subdivided into cords, tails, rings, and handles, depending on the type of their extremities (e.g., open or connected). A theoretical analysis of the density of such motifs in random and scale-free networks is described, and an algorithm for identifying these motifs in general networks is presented. The potential of considering chains for network characterization has been illustrated with respect to five categories of real-world networks including 16 cases. Several interesting findings were obtained, including the fact that several chains were observed in real-world networks, especially the world wide web, books, and the power grid. The possibility of chains resulting from incompletely sampled networks is also investigated.

Estimation of the thickness and the optical parameters of several stacked thin films using optimization

The reverse engineering problem addressed in the present research consists of estimating the thicknesses and the optical constants of two thin films deposited on a transparent substrate using only transmittance data through the whole stack. No functional dispersion relation assumptions are made on the complex refractive index. Instead, minimal physical constraints are employed, as in previous works of some of the authors where only one film was considered in the retrieval algorithm. To our knowledge this is the first report on the retrieval of the optical constants and the thickness of multiple film structures using only transmittance data that does not make use of dispersion relations. The same methodology may be used if the available data correspond to normal reflectance. The software used in this work is freely available through the PUMA Project web page (http://www.ime.usp.br/similar to egbirgin/puma/). (C) 2008 Optical Society of America

An oracle approach for interaction neighborhood estimation in random fields

We consider the problem of interaction neighborhood estimation from the partial observation of a finite number of realizations of a random field. We introduce a model selection rule to choose estimators of conditional probabilities among natural candidates. Our main result is an oracle inequality satisfied by the resulting estimator. We use then this selection rule in a two-step procedure to evaluate the interacting neighborhoods. The selection rule selects a small prior set of possible interacting points and a cutting step remove from this prior set the irrelevant points. We also prove that the Ising models satisfy the assumptions of the main theorems, without restrictions on the temperature, on the structure of the interacting graph or on the range of the interactions. It provides therefore a large class of applications for our results. We give a computationally efficient procedure in these models. We finally show the practical efficiency of our approach in a simulation study.