Estimating Stable Factor Models By Indirect Inference

Financial returns exhibit common behavior described at best by factor models, but also fat tails, which may be captured by α-stable distributions. This paper concentrates on estimating factor models with multivariate α-stable distributed and independent factors and idiosyncratic noises under the assumption of time constant distribution (static factor models) or time-varying conditional distribution (GARCH factor models). While the simulation from such a distribution is straightforward, the estimation encounters difficulties. These difficulties are overcome in this paper by implementing the indirect inference estimation method with the multivariate Student’s t as the auxiliary distribution.