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A Better Asymmetric Model of Changing Volatility in Stock and Exchange Rate Returns: Trend-GARCH

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  • Christian Bauer

Abstract

The impact of short run price trending on the conditional volatility is tested empirically. A new family of conditionally heteroscedastic models with a trend-dependent conditional variance equation: The Trend-GARCH model is described. Modern microeconomic theory often suggests the connection between the past behaviour of time series, the subsequent reaction of market individuals, and thereon changes in the future characteristics of the time series. Results reveal important properties of these models, which are consistent with stylized facts found in financial data sets. They can also be employed for model identification, estimation, and testing. The empirical analysis supports the existence of trend effects. The Trend-GARCH model proves to be superior to alternative models such as EGARCH, AGARCH, TGARCH OR GARCH-in-Mean in replicating the leverage effect in the conditional variance, in fitting the news impact curve and in fitting the volatility estimates from high frequency data. In addition, we show that the leverage effect is dependent on the current trend, i.e. it differentiates between bullish and bearish markets. Furthermore, trend effects can account for a significant part of the long memory property of asset price volatilities.

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  • Christian Bauer, 2007. "A Better Asymmetric Model of Changing Volatility in Stock and Exchange Rate Returns: Trend-GARCH," The European Journal of Finance, Taylor & Francis Journals, vol. 13(1), pages 65-87.
    • Handle: RePEc:taf:eurjfi:v:13:y:2007:i:1:p:65-87
    DOI: 10.1080/13518470600763752
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    1. Hernández del Valle Gerardo & Juárez-Torres Miriam & Guerrero Santiago, 2016. "A Functional Approach to Test Trending Volatility," Working Papers 2016-04, Banco de México.
    2. Bauer, Christian & De Grauwe, Paul & Reitz, Stefan, 2009. "Exchange rate dynamics in a target zone--A heterogeneous expectations approach," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 329-344, February.
    3. Santiago Guerrero & Gerardo Hernández†del†Valle & Miriam Juárez†Torres, 2017. "Using a functional approach to test trending volatility in the price of Mexican and international agricultural products," Agricultural Economics, International Association of Agricultural Economists, vol. 48(1), pages 3-13, January.
    4. Lourdes Uribe & Benjamin Perea & Gerardo Hernández-del-Valle & Oliver Schütze, 2018. "A Hybrid Metaheuristic for the Efficient Solution of GARCH with Trend Models," Computational Economics, Springer;Society for Computational Economics, vol. 52(1), pages 145-166, June.
    5. Nikolaos Stoupos & Apostolos Kiohos, 2021. "BREXIT referendum’s impact on the financial markets in the UK," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 157(1), pages 1-19, February.

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