Modelling Changes in the Unconditional Variance of Long Stock Return Series

Cristina Amado () and Timo Teräsvirta

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

Abstract: In this paper we develop a testing and modelling procedure for describing the long-term volatility movements over very long return series. For the purpose, we assume that volatility is multiplicatively decomposed into a conditional and an unconditional component as in Amado and Teräsvirta (2011). The latter component is modelled by incorporating smooth changes so that the unconditional variance is allowed to evolve 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 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 long-memory property in volatility may be explained by ignored changes in the unconditional variance of the long series. Finally, based on a formal statistical test we find evidence of the superiority of volatility forecast accuracy of the new model over the GJR-GARCH model at all horizons for a subset of the long return series.

Keywords: Model specification; Conditional heteroskedasticity; Lagrange multiplier test; Timevarying 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)
Pages: 30
Date: 2012
New Economics Papers: this item is included in nep-ets, nep-fmk and nep-for
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Modelling changes in the unconditional variance of long stock return series (2014)
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:aah:create:2012-07

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