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Modeling structural changes in the volatility process

Author Info

  • Frijns, Bart
  • Lehnert, Thorsten
  • Zwinkels, Remco C.J.

Abstract

GARCH-type models have been very successful in describing the volatility dynamics of financial return series for short periods of time. However, the time-varying behavior of investors, for example, may cause the structure of volatility to change and the assumption of stationarity is no longer plausible. To deal with this issue, the current paper proposes a conditional volatility model with time-varying coefficients based on a multinomial switching mechanism. By giving more weight to either the persistence or shock term in a GARCH model, conditional on their relative ability to forecast a benchmark volatility measure, the switching reinforces the persistent nature of the GARCH model. The estimation of this benchmark volatility targeting or BVT-GARCH model for Dow 30 stocks indicates that the switching model is able to outperform a number of relevant GARCH setups, both in- and out-of-sample, also without any informational advantages.

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Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 18 (2011)
Issue (Month): 3 (June)
Pages: 522-532

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Handle: RePEc:eee:empfin:v:18:y:2011:i:3:p:522-532
Contact details of provider: Web page: http://www.elsevier.com/locate/jempfin

Keywords: GARCH Time varying coefficients Multinomial logit;

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Find related papers by JEL classification:
  • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
  • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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  1. Thorsten Lehnert & Bart Frijns & Remco Zwinkels, 2009. "Behavioral Heterogeneity in the Option Market," LSF Research Working Paper Series 09-07, Luxembourg School of Finance, University of Luxembourg.
  2. Cristina Amado & Timo Teräsvirta, 2008. "Modelling Conditional and Unconditional Heteroskedasticity with Smoothly Time-Varying Structure," NIPE Working Papers 03/2008, NIPE - Universidade do Minho.
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  9. Peter Christoffersen & Kris Jacobs, 2004. "Which GARCH Model for Option Valuation?," Management Science, INFORMS, vol. 50(9), pages 1204-1221, September.
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  12. Franc Klaassen, 2002. "Improving GARCH volatility forecasts with regime-switching GARCH," Empirical Economics, Springer, vol. 27(2), pages 363-394.
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Cited by:

  1. Stefano Grassi & Paolo Santucci de Magistris, 2013. "It's all about volatility of volatility: evidence from a two-factor stochastic volatility model," Studies in Economics 1404, School of Economics, University of Kent.
  2. Menelaos Karanasos & Alexandros Paraskevopoulos & Faek Menla Ali & Michail Karoglou & Stavroula Yfanti, 2014. "Modelling Returns and Volatilities During Financial Crises: a Time Varying Coefficient Approach," Papers 1403.7179, arXiv.org.
  3. BOUSALAM, Issam & HAMZAOUI, Moustapha & ZOUHAYR, Otman, 2016. "Forecasting Daily Stock Volatility Using GARCH-CJ Type Models with Continuous and Jump Variation," MPRA Paper 69636, University Library of Munich, Germany.

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