Abstract:
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The family of multiplicative error models is important for studying non-negative variables such as realized volatility, trading volume, and duration between consecutive financial transactions. We develop new methods for testing the parametric specification of a multiplicative error model, which consists of separate parametric models for the conditional mean and the error distribution. Same methods can also be used for testing the specification of the error distribution provided the conditional mean is correctly specified. A bootstrap method is proposed for computing the p-values of the tests and is shown to be consistent. The proposed tests have nontrivial asymptotic power against a class of non-parametric local alternatives. The tests performed well in a simulation study. The testing procedure is illustrated by using a data example on realized volatility.
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