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What They Did Not Tell You About Algebraic (Non-)Existence, Mathematical (IR-)Regularity and (Non-)Asymptotic Properties of the Dynamic Conditional Correlation (DCC) Model

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McAleer, Michael (2019) What They Did Not Tell You About Algebraic (Non-)Existence, Mathematical (IR-)Regularity and (Non-)Asymptotic Properties of the Dynamic Conditional Correlation (DCC) Model. [ Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE); nº 17, 2019, ISSN: 2341-2356 ]

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Abstract

In order to hedge efficiently, persistently high negative covariances or, equivalently, correlations, between risky assets and the hedging instruments are intended to mitigate against financial risk and subsequent losses. If there is more than one hedging instrument, multivariate covariances and correlations will have to be calculated. As optimal hedge ratios are unlikely to remain constant using high frequency data, it is essential to specify dynamic time-varying models of covariances and correlations. These values can either be determined analytically or numerically on the basis of highly advanced computer simulations. Analytical developments are occasionally promulgated for multivariate conditional volatility models. The primary purpose of the paper is to analyse purported analytical developments for the only multivariate dynamic conditional correlation model to have been developed to date, namely Engle’s (2002) widely-used Dynamic Conditional Correlation (DCC) model. Dynamic models are not straightforward (or even possible) to translate in terms of the algebraic existence, underlying stochastic processes, specification, mathematical regularity conditions, and asymptotic properties of consistency and asymptotic normality, or the lack thereof. The paper presents a critical analysis, discussion, evaluation and presentation of caveats relating to the DCC model, and an emphasis on the numerous dos and don’ts in implementing the DCC and related model in practice.


Item Type:Working Paper or Technical Report
Uncontrolled Keywords:Hedging, Covariances, Correlations, Existence, Mathematical regularity, Invertibility, Likelihood function, Statistical asymptotic properties, Caveats, Practical implementation.
Subjects:Sciences > Mathematics > Finance
Social sciences > Economics > Econometrics
JEL:C22, C32, C51, C52, C58, C62, G32
Series Name:Documentos de Trabajo del Instituto Complutense de Análisis Económico (ICAE)
Volume:2019
Number:17
ID Code:54809
Deposited On:01 Apr 2019 09:34
Last Modified:01 Apr 2019 09:34

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