Bayesian Nonparametric Modelling of the Return Distribution with Stochastic Volatility

This paper presents a method for Bayesian nonparametric analysis of the return distribution in a stochastic volatility model. The distribution of the logarithm of the squared return is flexibly modelled using an infinite mixture of Normal distributions. This allows efficient Markov chain Monte Carlo methods to be developed. Links between the return distribution and the distribution of the logarithm of the squared returns are discussed. The method is applied to simulated data, two asset return series and two stock index return series. We find that estimates of volatility using the model can differ dramatically from those using a Normal return distribution if there is evidence of a heavy-tailed return distribution