Conditional Correlation Models of Autoregressive Conditional Heteroskedasticity with Nonstationary GARCH Equations

Cristina Amado () and Timo Teräsvirta

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: In this paper we investigate the effects of careful modelling the long-run dynamics of the volatil- ities of stock market returns on the conditional correlation structure. To this end we allow the individual unconditional variances in Conditional Correlation GARCH models to change smoothly over time by incorporating a nonstationary component in the variance equations. The modelling technique to determine the parametric structure of this time-varying component is based on a sequence of specification Lagrange multiplier-type tests derived in Amado and Teräsvirta (2011). The variance equations combine the long-run and the short-run dynamic behaviour of the volatilities. The structure of the conditional correlation matrix is assumed to be either time independent or to vary over time. We apply our model to pairs of seven daily stock returns belonging to the S&P 500 composite index and traded at the New York Stock Exchange. The results suggest that accounting for deterministic changes in the unconditional variances considerably improves the fit of the multivariate Conditional Correlation GARCH models to the data. The effect of careful specification of the variance equations on the estimated correlations is variable: in some cases rather small, in others more discernible. As a by-product, we generalize news impact surfaces to the situation in which both the GARCH equations and the conditional correlations contain a deterministic component that is a function of time.

Keywords: Multivariate GARCH model; Time-varying unconditional variance; Lagrange multiplier test; Modelling cycle; Nonlinear time series. (search for similar items in EconPapers)
JEL-codes: C12 C32 C51 C52 (search for similar items in EconPapers)
Pages: 38
Date: 2011-05-30
New Economics Papers: this item is included in nep-ets and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Conditional Correlation Models of Autoregressive Conditional Heteroskedasticity with Nonstationary GARCH Equations (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2011-24

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