Factor Stochastic Volatility in Mean Models: A GMM Approach

This paper provides a semiparametric framework for modeling multivariate conditional heteroskedasticity. We put forward latent stochastic volatility (SV) factors as capturing the commonality in the joint conditional variance matrix of asset returns. This approach is in line with common features as studied by Engle and Kozicki (1993), and it allows us to focus on identication of factors and factor loadings through first- and second-order conditional moments only. We assume that the time-varying part of risk premiums is based on constant prices of factor risks, and we consider a factor SV in mean model. Additional specification of both expectations and volatility of future volatility of factors provides conditional moment restrictions, through which the parameters of the model are all identied. These conditional moment restrictions pave the way for instrumental variables estimation and GMM inference.