Stochastic Volatility Models with Skewness Selection
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Updated: Jul 2, 2025

Measuring the Subjective Value of Risky and Ambiguous Options using Experimental Economics and Functional MRI Methods
Published on: September 19, 2012
Igor Martins1, Hedibert Freitas Lopes1
1Insper Institute of Education and Research, Rua Quatá 300, São Paulo 04546-042, Brazil.
Abstract:
This paper expands traditional stochastic volatility models by allowing for time-varying skewness without imposing it. While dynamic asymmetry may capture the likely direction of future asset returns, it comes at the risk of leading to overparameterization. Our proposed approach mitigates this concern by leveraging sparsity-inducing priors to automatically select the skewness parameter as dynamic, static or zero in a data-driven framework. We consider two empirical applications. First, in a bond yield application, dynamic skewness captures interest rate cycles of monetary easing and tightening and is partially explained by central banks' mandates. In a currency modeling framework, our model indicates no skewness in the carry factor after accounting for stochastic volatility. This supports the idea of carry crashes resulting from volatility surges instead of dynamic skewness.
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