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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Realized Jumps on Financial Markets and Predicting Credit Spreads
George Tauchen and Hao Zhou

Abstract: This paper extends the jump detection method based on bi-power variation to identify realized jumps on financial markets and to estimate parametrically the jump intensity, mean, and variance. Finite sample evidence suggests that jump parameters can be accurately estimated and that the statistical inferences can be reliable, assuming that jumps are rare and large. Applications to equity market, treasury bond, and exchange rate reveal important differences in jump frequencies and volatilities across asset classes over time. For investment grade bond spread indices, the estimated jump volatility has more forecasting power than interest rate factors and volatility factors including option-implied volatility, with control for systematic risk factors. A market jump risk factor seems to capture the low frequency movements in credit spreads.

Keywords: Jump-Diffusion Process, Realized variance, bi-power variation, realized jumps, jump volatility, credit risk premium.

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Last update: November 9, 2006