On the Origins of Conditional Heteroscedasticity in Time Series
The volatility clustering frequently observed in financial/economic time series is often ascribed to GARCH and/or stochastic volatility models. This paper demonstrates the usefulness of re- conceptualizing the usual definition of conditional heteroscedasticity as the (h = 1) special case of h-step-ahead conditional heteroscedasticity, where the conditional volatility in period t depends on observable variables up through period t - h. Here it is shown that, for h > 1, h-step-ahead conditional heteroscedasticity arises â€“ necessarily and endogenously â€“ from nonlinear serial dependence in a time series; whereas one-step-ahead conditional heteroscedasticity (i.e., h= 1) requires multiple and heterogeneously-skedastic innovation terms. Consequently, the best response to observed volatility clustering may often be to model the nonlinear serial dependence which is likely causing it, rather than â€˜tacking onâ€™ an ad hoc volatility model. Even where such nonlinear modeling is infeasible â€“ or where volatility is quantified using, say, a model-free implied volatility measure rather than squared returns â€“ these results suggest a re-consideration of the usefulness of lag-one terms in volatility models. An application to observed daily stock returns is given.
|Date of creation:||2010|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.econ.vt.edu
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Terasvirta, T & Anderson, H M, 1992. "Characterizing Nonlinearities in Business Cycles Using Smooth Transition Autoregressive Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages S119-36, Suppl. De.
When requesting a correction, please mention this item's handle: RePEc:vpi:wpaper:e07-23. See general 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: (Djavad Salehi-Isfahani)
If references are entirely missing, you can add them using this form.