Hierarchical modeling of irregularly spaced financial returns

Abstract

Volatility modeling is crucial in finance, especially when dealing with intraday transaction‐level asset returns. The irregular and high‐frequency nature of the data presents unique challenges. While stochastic volatility (SV) models are widely used for understanding patterns in volatility of daily stock returns which constitute regularly spaced time series, new classes of models must be introduced for analyzing volatility in irregularly spaced intraday data. Specifically these models must accommodate the random gaps between successive transactional events. By modeling the gaps using autoregressive conditional duration (ACD) models, we describe a hierarchical irregular SV autoregressive conditional duration (IR‐SV‐ACD) model for estimating and forecasting intertransaction gaps and the volatility of log‐returns. We carry out the analysis in the Bayesian framework via the Hamiltonian Monte Carlo (HMC) algorithm with No‐U‐turn sampler (NUTS) in R using the cmdstanr package. The fits and forecasts are obtained using Monte Carlo averages based on the posterior samples. We illustrate this approach using simulation studies and real data analysis for intraday prices available at microseconds level of health stocks traded on the New York Stock Exchange (NYSE). The log‐returns and gaps are calculated for the stocks and are used for modeling.