Modelling changes in the unconditional variance of long stock return series

Cristina Amado () and Timo Teräsvirta

Journal of Empirical Finance, 2014, vol. 25, issue C, 15-35

Abstract: In this paper we develop a testing and modelling procedure for describing the long-term volatility movements over very long daily return series. For this purpose we assume that volatility is multiplicatively decomposed into a conditional and an unconditional component as in Amado and Teräsvirta (2012, 2013). The latter component is modelled such that the unconditional time-varying component evolves slowly over time. Statistical inference is used for specifying the parameterization of the time-varying component by applying a sequence of Lagrange multiplier tests. The model building procedure is illustrated with an application to 22,986 daily returns of the Dow Jones Industrial Average stock index covering a period of more than ninety years. The main conclusions are as follows. First, the LM tests strongly reject the assumption of constancy of the unconditional variance. Second, the results show that the apparent long memory property in volatility may be interpreted as changes in the unconditional variance of the long series. Finally, based on a formal statistical test we find evidence of the superiority of volatility forecasting accuracy of the new model over the GJR-GARCH model at all horizons for eight subsets of the long return series.

Keywords: Model specification; Conditional heteroskedasticity; Lagrange multiplier test; Time-varying unconditional variance; Long financial time series; Volatility persistence (search for similar items in EconPapers)
JEL-codes: C12 C22 C51 C52 C53 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (40)

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Related works:
Working Paper: Modelling Changes in the Unconditional Variance of Long Stock Return Series (2012)
Working Paper: Modelling Changes in the Unconditional Variance of Long Stock Return Series (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:25:y:2014:i:c:p:15-35

DOI: 10.1016/j.jempfin.2013.09.003

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