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Detection of Breakpoints in Volatility

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  • Viviana Fernandez

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Abstract

Financial time-series may exhibit breakpoints in unconditional variance due, possibly, to institutional changes. Accounting for such shifts is essential to risk management, forecasting, and hedging. In this article, we test for the presence of structural breaks in volatility by two approaches: the Iterative Cumulative Sum of Squares (ICSS) algorithm and wavelet analysis. We present a series of examples in which we compare both methods. Specifically, we look at the effect of the outbreak of the Asian crisis and the terrorist attacks of September 11, 2001 on Emerging Asia, Europe, Latin America and North America’s stock markets. In addition, we focus on the behavior of interest rates in Chile after the Central Bank switched its monetary policy interest rate from an inflation-indexed to a nominal target in August 2001. Our estimation results show that the number of shifts detected by the two methods is substantially reduced when filtering out the data for both conditional heteroskedasticity and serial correlation.

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Bibliographic Info

Paper provided by Centro de Economía Aplicada, Universidad de Chile in its series Documentos de Trabajo with number 194.

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Date of creation: 2004
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Handle: RePEc:edj:ceauch:194

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  1. Felipe Morandé, 2002. "Nominalización de la Tasa de Política Monetaria. Debate y Consecuencias," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 39(117), pages 239-252.
  2. Lamoureux, Christopher G & Lastrapes, William D, 1990. "Persistence in Variance, Structural Change, and the GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 8(2), pages 225-34, April.
  3. Ramsey James B. & Lampart Camille, 1998. "The Decomposition of Economic Relationships by Time Scale Using Wavelets: Expenditure and Income," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 3(1), pages 1-22, April.
  4. Ser-Huang Poon & Clive W.J. Granger, 2003. "Forecasting Volatility in Financial Markets: A Review," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 478-539, June.
  5. Aggarwal, Reena & Inclan, Carla & Leal, Ricardo, 1999. "Volatility in Emerging Stock Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(01), pages 33-55, March.
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Cited by:
  1. Boussard, Jean-Marc, 2007. "The future of the European Common Agricultural Policy : a new philosopy ?," Miscellaneous Papers 44423, Agecon Search.
  2. Morales, Lucía & Gassie, Esmeralda, 2011. "Structural breaks and financial volatility: Lessons from BRIC countries," IAMO Forum 2011: Will the "BRICs Decade" Continue? – Prospects for Trade and Growth 13, Leib­niz Institute of Agricultural Development in Central and Eastern Europe (IAMO).
  3. Mala Raghavan & Jonathan Dark & Elizabeth Ann Maharaj, 2010. "Impact of capital control measures on the Malaysian stock market: A multiresolution analysis," International Journal of Managerial Finance, Emerald Group Publishing, Emerald Group Publishing, vol. 6(2), pages 116-127, April.

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