Building Multivariate Time-Varying Smooth Transition Correlation GARCH Models, with an Application to the Four Largest Australian Banks

Abstract

This paper proposes a methodology for building Multivariate Time-Varying STCC–GARCH models. The novel contributions in this area are the specification tests related to the correlation component, the extension of the general model to allow for additional correlation regimes, and a detailed exposition of the systematic, improved modelling cycle required for such nonlinear models. There is an R-package that includes the steps in the modelling cycle. Simulations demonstrate the robustness of the recommended model building approach. The modelling cycle is illustrated using daily return series for Australia’s four largest banks.

Keywords

• unconditional correlation
• modelling volatility
• modelling correlations
• multivariate autoregressive conditional heteroskedasticity