WIAS Preprint No. 977, (2004)

Varying coefficient GARCH versus local constant volatility modeling. Comparison of the predictive power



Authors

  • Polzehl, Jörg
    ORCID: 0000-0001-7471-2658
  • Spokoiny, Vladimir
    ORCID: 0000-0002-2040-3427

2010 Mathematics Subject Classification

  • 91B84 62P05

Keywords

  • varying coefficient GARCH, adaptive weights

DOI

10.20347/WIAS.PREPRINT.977

Abstract

GARCH models are widely used in financial econometrics. However, we show by mean of a simple simulation example that the GARCH approach may lead to a serious model misspecification if the assumption of stationarity is violated. In particular, the well known integrated GARCH effect can be explained by nonstationarity of the time series. We then introduce a more general class of GARCH models with time varying coefficients and present an adaptive procedure which can estimate the GARCH coefficients as a function of time. We also discuss a simpler semiparametric model in which the ( beta )-parameter is fixed. Finally we compare the performance of the parametric, time varying nonparametric and semiparametric GARCH(1,1) models and the locally constant model from Polzehl and Spokoiny (2002) by means of simulated and real data sets using different forecasting criteria. Our results indicate that the simple locally constant model outperforms the other models in almost all cases. The GARCH(1,1) model also demonstrates a relatively good forecasting performance as far as the short term forecasting horizon is considered. However, its application to long term forecasting seems questionable because of possible misspecification of the model parameters.

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