The Specification of GARCH Models with Stochastic Covariates

29 Pages Posted: 9 Oct 2007

See all articles by Jeff Fleming

Jeff Fleming

Rice University - Jesse H. Jones Graduate School of Business

Chris Kirby

UNC Charlotte - Belk College of Business

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: June 19, 2006

Abstract

A number of studies investigate whether various stochastic variables explain changes in return volatility by specifying the variables as covariates in a GARCH(1,1) or EGARCH(1,1) model. We show that these models impose an implicit constraint which can obscure the true role of the covariates in the analysis. To illustrate the problem, we reconsider the role of contemporaneous trading volume in explaining ARCH effects in daily stock returns. Once we relax the constraint imposed in prior research, we find that specifying volume as a covariate does little to diminish the importance of lagged squared returns in capturing the dynamics of volatility.

Keywords: two-component GARCH, bivariate mixture models, volume-volatility relation

JEL Classification: C22, G10

Suggested Citation

Fleming, Jeff and Kirby, Chris and Ostdiek, Barbara, The Specification of GARCH Models with Stochastic Covariates (June 19, 2006). Available at SSRN: https://ssrn.com/abstract=1019291 or http://dx.doi.org/10.2139/ssrn.1019291

Jeff Fleming

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-4677 (Phone)
713-348-5251 (Fax)

HOME PAGE: http://www.ruf.rice.edu/~jfleming

Chris Kirby (Contact Author)

UNC Charlotte - Belk College of Business ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

Barbara Ostdiek

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-5384 (Phone)
713-348-5251 (Fax)

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