What Good is a Volatility Model?
29 Pages Posted: 7 Nov 2008
Date Written: January 2001
A volatility model must be able to forecast volatility; this is the central requirement in almost all financial applications. In this paper we outline some stylised facts aboutvolatility that should be incorporated in a model; pronounced persistence and meanreversion, asymmetry such that the sign of an innovation also affects volatility and the possibility of exogenous or pre-determined variables influencing volatility. We use data on the Dow Jones Industrial index to illustrate these stylised facts, and the ability of GARCH-type models to capture these features. We conclude with some challenges for future research in this area.
Keywords: volatility modelling, ARCH, GARCH, volatility forecasting
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