A Simulation and Empirical Study of the Maximum Likelihood Estimator for Stochastic Volatility Jump-Diffusion Models

We investigate the behaviour of the maximum likelihood estimator (MLE) for stochastic volatility jump-diffusion models commonly used in financial risk management. A simulation study shows the practical conditions under which the MLE behaves according to theory. In an extensive empirical study based on nine indices and more than 6000 individual stocks, we nonetheless find that the MLE is unable to replicate key higher moments. We then introduce a moment-targeted MLE – robust to model misspecification – and revisit both simulation and empirical studies. We find it performs better than the MLE, improving the management of financial risk.