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Structural breaks and GARCH models of stock return volatility: The case of South Africa

Ali Babikir, Rangan Gupta (), Chance Mwabutwa and Emmanuel Owusu-Sekyere ()

Economic Modelling, 2012, vol. 29, issue 6, 2435-2443

Abstract: This paper investigates the empirical relevance of structural breaks in forecasting stock return volatility using both in-sample and out-of-sample tests applied to daily returns of the Johannesburg Stock Exchange (JSE) All Share Index from 07/02/1995 to 08/25/2010. We find evidence of structural breaks in the unconditional variance of the stock returns series over the period, with high levels of persistence and variability in the parameter estimates of the GARCH(1,1) model across the sub-samples defined by the structural breaks. This indicates that structural breaks are empirically relevant to stock return volatility in South Africa. However, based on the out-of-sample forecasting exercise, we find that even though there structural breaks in the volatility, there are no statistical gains from using competing models that explicitly accounts for structural breaks, relative to a GARCH(1,1) model with expanding window. This could be because of the fact that the two identified structural breaks occurred in our out-of-sample, and recursive estimation of the GARCH(1,1) model is perhaps sufficient to account for the effect of the breaks on the parameter estimates. Finally, we highlight that, given the point of the breaks, perhaps what seems more important in South Africa, is accounting for leverage effects, especially in terms of long-horizon forecasting of stock return volatility.

Keywords: Stock return volatility; Structural breaks; In-sample tests; Out-of-sample tests; GARCH models (search for similar items in EconPapers)
JEL-codes: C22 C53 G11 G12 (search for similar items in EconPapers)
Date: 2012
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Working Paper: Structural Breaks and GARCH Models of Stock Return Volatility: The Case of South Africa (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:29:y:2012:i:6:p:2435-2443

DOI: 10.1016/j.econmod.2012.06.038

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