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where
For example, if the asset return was unexpectedly large in either the
upward or the downward direction, then the trader will increase the
estimate of the variance for the next period. This model is consistent
with the volatility clustering often seen in financial returns data, where
large changes in returns are likely to be followed by further large
changes.
A. The ARCH Specification
y t xt' r t2 ~
r t
where p is the order of the GARCH terms and q is the order of the
ARCH term.
a) Quick/Estimate Equation/ARCH
b) Option:
Heteroskedasticity Consistent Covariances: You should use this option if you
suspect that the residuals are not conditionally normally distributed.
c) The Mean Equation:
You can enter the specification in list form by listing the dependent variable
followed by the regressors. You should add the C to your specification if you
wish to include a constant. If your specification includes an ARCH-M term,
you should click on the appropriate radio button in the upper right-hand side of
the dialog.
d) The variance Equation
①Under the ARCH specification label, you should choose the number of
ARCH and GARCH terms.
②In the edit box labeled Variance Regressors, you may optionally list
variables you wish to include in the variance specification. Note that
EViews will always include a constant as a variance regressor so that you
do not need to add C to the list.
B. Estimating ARCH models in EViews
Examples 1
GARCH(1,1)
To estimate a standard GARCH(1,1) model with no regressors in the mean and
variance equations.
Rt c t
t2 t21 t21
Examples 2
NYS t r0 r1 DUM t r2 t t
t2 1 t21 2 t2 2 3 t23 4 t24 r3 DUM t
a) Quick/Estimate Equation/ARCH
b) NYS c DUM
c) Enter 4 for the ARCH term and 0 for the GARCH term, and select
GARCH (symmetric).
d) Select std. Dev. for the ARCH-M term
e) enter DUM in the Variance Regressors edit box.
Click
B. Estimating ARCH models in EViews
Examples 3
Examples 3
Steps:
The interest equation was first estimated, its estimated residuals squared, and
the auxiliary regression for the variance estimated. R2 for this regression was
0.126, but nR2=3.91 has p-value 0.27, which in not significant for x2 test. Thus,
ARCH(3) is not supported. However, the ARCH(1) term was significant at the
level 0.09, so an ARCH(1) specification was tested next. The p-value for this
test was 0.048, which indicates significant at the 5 percent level. Because the
deficit term D2 was insignificant, it was excluded from the model in order to
improve the precision of the other variables and to reduce any multicollinearity
that may be present. The final model is given below with p-values in
parentheses:
rˆt 3.38 0.0283M t 1 0.0262 M t 2 0.0347 Dt 1
( 0.01) ( 0.01) ( 0.01) ( 0.01)
R 2 .464
B. Estimating ARCH models in EViews
Once your model has been estimated, EViews provides a variety of views and
procedures for inference and diagnostic checking.
This view can be used to test for remaining serial correlation in the mean
equation and to check the specification of the mean equation. If the mean
equation is correctly specified, all Q-statistics should not be significant.
q
(2) Variance equation: (i )
We can also apply Ljung-Box Q2 test:
Q 2
( q ) T (T 2 ) T i
i 1
and use ACF and PACF to decide the number of lag for GARCH (p, q ).
This view can be used to test for remaining ARCH in the variance equation
and to check the specification of the variance equation. If the variance
equation is correctly specified, all Q-statistics should not be significant.
Q-statistics Q 2 -statistics
C. Asymmetric ARCH Models
Volatility
News
C. Asymmetric ARCH Models
In this model, good news (εt>0 ), and bad new (εt<0 ), have differential
effects on the conditional variance—good news has an impact of α,
while bad news has an impact of α+ r. If r>0 we say that the leverage
effect exists. If r≠0, the news impact is asymmetric.
C. Asymmetric ARCH Models
1) Quick/Estimate Equation
2) ARCH specification.
3) Rc
4) TARCH
log t2 log t21
t 1
t 1
r t 1
t 1
Note that the left-hand side is the log of the conditional variance. This
implies that the leverage effect is exponential, and that forecasts of the
conditional variance are guaranteed to be nonnegative. The presence
of leverage effects can be tested by the hypothesis that r > 0. The
impact is asymmetric if r≠ 0.
C. Asymmetric ARCH Models
t i
p q
log t2 2
j log t j i ri t i
j 1 i 1 t i t i
log z
log t2 t21 t 1 r z t 1
2. GARCH(1,1)-MA(1) model
Rt 0 1 t2 t t 1
t2 t21 t21 r MON t
The mean equation includes the conditional variance and the errors
are MA(1). The MON series in the conditional variance equation is
a dummy variable for Monday, which is meant to capture the non-
trading period effect during the weekend.
D. EViews Example
3. Test
a) Open/workfile/Example/data/gerus
b) Quick/Estimate Equation/ARCH
c) ARCH specification: R c ma(1)
d) Variance Regressors: mon
e) 11
f) Select Variance for the ARCH-M
g) View/Residual Tests/ARCH LM Test/7
The top part of the output from testing up to an ARCH(7) is given by
ARCH TEST:
F-statistic 0.1163 Probability 0.9970
Obs*R-squared 0.8836 Probability 0.9964
3. Test
h) View/Residual Tests/Historgram-Normality test
The residuals are highly leptokurtic and the Jarque-Bera (JB) test
decisively rejects the normal distribution.
JB test is a test statistic for testing whether the series is normally
distributed. The test statistic measures the difference of the skewness
and kurtosis of the series with those from the normal distribution.
N k 2 K 3
2
Jarque-Bera= S
6 4