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Modelling Stochastic Volatility in the Kenyan Securities Market Using Hidden Markov Models

¹ Strathmore University, Institute of Mathematical Sciences, Nairobi, Kenya
² Strathmore University, Institute of Mathematical Sciences, Nairobi, Kenya

Journal of Financial Risk Management·Volume 10 (2021)·Pages 367–395·Published 2 August 2021·DOI10.4236/jfrm.2021.103021

Abstract

This paper models stochastic volatility using Hidden Markov Models in Kenya. The univariate Stochastic volatility Model is calibrated to the Nairobi Securities Exchange 20 share index daily data from January 2012 to February 2021. The Hidden Markov model (HMM) is employed to establish volatility regimes while the Expected Maximization (EM) algorithm is applied in pa rameter estimation. Markov Chain Monte Carlo (MCMC) and Sequential Monte Carlo (SMC) techniques are employed in filtering out noisy observations in parameter estimation. The 4-state model, which divides the economy into periods of very high, high, low, and very low volatility, is established to be optimal.

KeywordsHidden Markov ModelsStochastic VolatilityNairobi Securities Exchange 20 (NSE 20) Share IndexVolatility Regimes

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Modelling Stochastic Volatility in the Kenyan Securities Market Using Hidden Markov Models

Abstract

References (17)