Department of Economics and Business Economics

Unstable volatility functions: the break preserving local linear estimator

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  • Rp09 48

    Final published version, 417 KB, PDF document

  • Isabel Casas, Denmark
  • Irene Gijbels, Katholieke Universiteit Leuven, Belgium
  • School of Economics and Management
The objective of this paper is to introduce the break preserving local linear
(BPLL) estimator for the estimation of unstable volatility functions. Breaks in
the structure of the conditional mean and/or the volatility functions are common
in Finance. Markov switching models (Hamilton, 1989) and threshold models
(Lin and Terasvirta, 1994) are amongst the most popular models to describe the
behaviour of data with structural breaks. The local linear (LL) estimator is not
consistent at points where the volatility function has a break and it may even
report negative values for finite samples. The estimator presented in this paper
generalises the classical LL. The BPLL maintains the desirable properties of the
LL with regard to the bias and the boundary estimation, it estimates the breaks
consistently and it ensures that the volatility estimates are always positive.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages25
Publication statusPublished - 2009

    Research areas

  • Breaks estimation, Heteroscedasticity, Local linear regression, Nonlinear time series, Volatility estimation

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