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Forecasting stock market volatility conditional on macroeconomic conditions

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Author Info
Ralf Becker
Adam Clements ()

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Abstract

This paper presents a GARCH type volatility model with a time-varying unconditional volatility which is a function of macroeconomic information. It is an extension of the SPLINE GARCH model proposed by Engle and Rangel (2005). The advantage of the model proposed in this paper is that the macroeconomic information available (and/or forecasts)is used in the parameter estimation process. Based on an application of this model to S&P500 share index returns, it is demonstrated that forecasts of macroeconomic variables can be easily incorporated into volatility forecasts for share index returns. It transpires that the model proposed here can lead to significantly improved volatility forecasts compared to traditional GARCH type volatility models.

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Paper provided by National Centre for Econometric Research in its series NCER Working Paper Series with number 18.

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Length: 33
Date of creation: 14 Jun 2007
Date of revision:
Handle: RePEc:qut:auncer:2007-93

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Related research
Keywords: Volatility; macroeconomic data; forecast; spline; GARCH.;

Find related papers by JEL classification:
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
G00 - Financial Economics - - General - - - General

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  1. Muller, Ulrich A. & Dacorogna, Michel M. & Dave, Rakhal D. & Olsen, Richard B. & Pictet, Olivier V. & von Weizsacker, Jacob E., 1997. "Volatilities of different time resolutions -- Analyzing the dynamics of market components," Journal of Empirical Finance, Elsevier, vol. 4(2-3), pages 213-239, June. [Downloadable!] (restricted)
  2. James D. Hamilton & Gang Lin, 1996. "Stock Market Volatility and The Business Cycle," University of California at San Diego, Economics Working Paper Series 96-18, Department of Economics, UC San Diego. [Downloadable!]
    Other versions:
  3. Ghysels, Eric & Santa-Clara, Pedro & Valkanov, Rossen, 2006. "Predicting volatility: getting the most out of return data sampled at different frequencies," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 59-95. [Downloadable!] (restricted)
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  5. Robert F. Engle & Jose Gonzalo Rangel, 2005. "The Spline GARCH Model for Unconditional Volatility and its Global Macroeconomic Causes," Working Papers 2005/13, Czech National Bank, Research Department. [Downloadable!]
  6. Eric Ghysels & Pedro Santa-Clara & Rossen Valkanov, 2004. "Predicting Volatility: Getting the Most out of Return Data Sampled at Different Frequencies," CIRANO Working Papers 2004s-19, CIRANO. [Downloadable!]
    Other versions:
  7. Bollerslev, Tim, 1987. "A Conditionally Heteroskedastic Time Series Model for Speculative Prices and Rates of Return," The Review of Economics and Statistics, MIT Press, vol. 69(3), pages 542-47, August. [Downloadable!] (restricted)
  8. Ding, Zhuanxin & Granger, Clive W. J. & Engle, Robert F., 1993. "A long memory property of stock market returns and a new model," Journal of Empirical Finance, Elsevier, vol. 1(1), pages 83-106, June. [Downloadable!] (restricted)
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  9. Officer, R R, 1973. "The Variability of the Market Factor of the New York Stock Exchange," Journal of Business, University of Chicago Press, vol. 46(3), pages 434-53, July. [Downloadable!] (restricted)
  10. Andersen, Torben G & Bollerslev, Tim, 1997. " Heterogeneous Information Arrivals and Return Volatility Dynamics: Uncovering the Long-Run in High Frequency Returns," Journal of Finance, American Finance Association, vol. 52(3), pages 975-1005, July. [Downloadable!] (restricted)
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  11. Elena Andreou & Eric Ghysels, 2001. "Detecting Multiple Breaks in Financial Market Volatility Dynamics," University of Cyprus Working Papers in Economics 0202, University of Cyprus Department of Economics. [Downloadable!]
    Other versions:
  12. Dacorogna, Michael M. & Muller, Ulrich A. & Nagler, Robert J. & Olsen, Richard B. & Pictet, Olivier V., 1993. "A geographical model for the daily and weekly seasonal volatility in the foreign exchange market," Journal of International Money and Finance, Elsevier, vol. 12(4), pages 413-438, August. [Downloadable!] (restricted)
  13. Hamilton, James D & Kim, Dong Heon, 2002. "A Reexamination of the Predictability of Economic Activity Using the Yield Spread," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 340-60, May.
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  14. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December. [Downloadable!] (restricted)
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