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Modeling the Volatility of the Dow Jones Islamic Market World Index Using a Fractionally Integrated Time Varying GARCH (FITVGARCH) Model

Listed author(s):
  • Adnen Ben Nasr


    (Laboratoire BESTMOD, ISG de Tunis, Universite de Tunis, Tunisia)

  • Ahdi N. Ajmi


    (College of Science and Humanities in Slayel, Salman bin Abdulaziz University, Kingdom of Saudi Arabia)

  • Rangan Gupta


    (Department of Economics, University of Pretoria)

Appropriate modeling of the process of volatility has implications for portfolio selection, the pricing of derivative securities and risk management. Further, a large body of research has suggested that both long memory and structural changes simultaneously characterize the structure of financial returns volatility. Given this, in this paper, we aim to model conditional volatility of the returns of the Dow Jones Islamic Market World Index (DJIM), interest on which has come to the fore following the need for renovation of the conventional financial system, in the wake of the recent global financial crisis. To model the conditional volatility of the DJIM returns, accounting for both long memory and structural changes, we allow the parameters in the conditional variance equation of the Fractionally Integrated Generalized Autoregressive Conditional Heteroskedasticity (FIGARCH) model to be time dependent, such that the parameters evolve smoothly over time based on a logistic smooth transition function, yielding a Fractionally Integrated Time Varying Generalized Autoregressive Conditional Heteroskedasticity (FITVGARCH) model. Our results show that, in terms of model diagnostics and information criteria, the FITVGARCH model performs better than the FIGARCH model in explaining conditional volatility of the DJIM returns, thus, highlighting the need to model simultaneously long-memory and structural changes in the volatility process of asset returns.

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Paper provided by University of Pretoria, Department of Economics in its series Working Papers with number 201357.

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Length: 27 pages
Date of creation: Sep 2013
Handle: RePEc:pre:wpaper:201357
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