Right on Target, or Is it? The Role of Distributional Shape in Variance Targeting

Econometrics, 3(3), pp. 610-632

23 Pages Posted: 1 Sep 2015

See all articles by Stanislav Anatolyev

Stanislav Anatolyev

New Economic School; CERGE-EI

Stanislav Khrapov

New Economic School (NES)

Date Written: August 10, 2015

Abstract

Estimation of GARCH models can be simplified by augmenting quasi-maximum likelihood (QML) estimation with variance targeting, which reduces the degree of parameterization and facilitates estimation. We compare the two approaches and investigate, via simulations, how non-normality features of the return distribution affect the quality of estimation of the volatility equation and corresponding value-at-risk predictions. We find that most GARCH coefficients and associated predictions are more precisely estimated when no variance targeting is employed. Bias properties are exacerbated for a heavier-tailed distribution of standardized returns, while the distributional asymmetry has little or moderate impact, these phenomena tending to be more pronounced under variance targeting. Some effects further intensify if one uses ML based on a leptokurtic distribution in place of normal QML. The sample size has also a more favorable effect on estimation precision when no variance targeting is used. Thus, if computational costs are not prohibitive, variance targeting should probably be avoided.

Keywords: GARCH, variance targeting, non-normality, heavy tails, skewness, quasi-maximum likelihood

JEL Classification: C22, C53, C58

Suggested Citation

Anatolyev, Stanislav and Khrapov, Stanislav, Right on Target, or Is it? The Role of Distributional Shape in Variance Targeting (August 10, 2015). Econometrics, 3(3), pp. 610-632, Available at SSRN: https://ssrn.com/abstract=2653563

Stanislav Anatolyev (Contact Author)

New Economic School ( email )

Skolkovskoe shosse, 45
Moscow, 121353
Russia

CERGE-EI ( email )

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Czech Republic

Stanislav Khrapov

New Economic School (NES) ( email )

100A Novaya Street, Skolkovo, Moscow
Moscow, 143026
Russia
+7 (495) 956 9508 (Phone)

HOME PAGE: http://sites.google.com/site/khrapovs/

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