Contemporaneous Aggregation of GARCH Models and Evaluation of the Aggregation Bias
AbstractIt is well known that the class of strong (Generalized) AutoRegressive Conditional Heteroskedasticity (or GARCH) processes is not closed under contemporaneous aggregation. This paper provides the dynamics followed by the aggregate process when the individual persistence parameters are drawn from the same (unknown) distribution. Assuming heterogeneity across individual parameters, the dynamics of the aggregate volatility involves additional lags that reflect the moments of the distribution of the individual persistence parameters. Then the paper describes a consistent estimator of the aggregate process, based on nonlinear least squares. A simulation study reveals that this aggregation-corrected estimator performs very well under realistic sets of parameters. Last, this approach is extended to a multi-sector context. This extension is used to evaluate the importance of the aggregation bias. Using size and book-to-market portfolios, I show that the investor is willing to pay one fifth of her expected return to switch from the standard GARCH (1,1) estimator to the aggregation-corrected estimator.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-06.
Length: 53 pages
Date of creation: Feb 2008
Date of revision:
Contemporaneous aggregation; Heterogeneity; Volatility; GARCH model.;
Find related papers by JEL classification:
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-04-12 (All new papers)
- NEP-ECM-2008-04-12 (Econometrics)
- NEP-ETS-2008-04-12 (Econometric Time Series)
- NEP-ORE-2008-04-12 (Operations Research)
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marilyn Barja).
If references are entirely missing, you can add them using this form.