Box-Cox Stochastic Volatility Models with Heavy-Tails and Correlated Errors

This paper presents a Markov chain Monte Carlo (MCMC) algorithm to estimate parameters and latent stochastic processes in the asymmetric stochastic volatility (SV) model, in which the Box-Cox transformation of the squared volatility follows an autoregressive Gaussian distribution and the marginal density of asset returns has heavytails. To test for the significance of the Box-Cox transformation parameter, we present the likelihood ratio statistic, in which likelihood functions can be approximated using a particle filter and a Monte Carlo kernel likelihood. When applying the heavy-tailed asymmetric Box-Cox SV model and the proposed sampling algorithm to continuously compounded daily returns of the Australian stock index, we find significant empirical evidence supporting the Box-Cox transformation of the squared volatility against the alternative model involving a logarithmic transformation. JEL Classification: C12; C15; C52