ARCH and GARCH

Modeling Volatility Dynamics

 Modeling Unequal Variability

• Equal Variability: Homoscedasticity

• Unequal Variability: Heteroscedasticity

– Means any variability (around the mean)
that is not homoscedasticity
– Models must be developed for specific
cases
 What These Acronym Mean?

• ARCH
– Autoregressive Conditional
Heteroscedasticity

• GARCH
– Generalized ARCH
 Information in e2

• Let et have the mean 0 and the variance st.

• Let et be the residual of a model fitted.

• Then:
– et estimates et

– et2 estimates the variance st2.

 ARCH Modeling of st2.

• ARCH(1)

s    e
t
2 2
( t 1)

• ARCH as AR(1) on e  s  t
t
2
t
2

e    e
t
2 2
( t 1)  t
 GARCH
• GARCH(1)

s    e
t
2 2
( t 1)  s 2
( t 1)

• GARCH (1) as ARMA(1,1) on e t

2
 s t  t
2

e        e
t
2 2
( t 1)  t   t 1
et  0

Asymmetry in GARCH - TARCH

• TARCH(1,1)

s    e
t
2 2
t 1   de 2
t 1s  s 2
t 1

d = 1 if et < 0, and = 0 if et > 0

Asymmetry in GARCH - EGARCH

• EGARCH(1,1)

e t 1 e t 1
log s 2
     log s 2
t 1  
s t 1 s t 1
t

s t2  0

  0 for asymmetric effect

 Eviews Command

ARCH(p, q) series_name c