A Volatility Targeting GARCH model with Time-Varying Coefficients

Thorsten Lehnert, Bart Frijns and Remco Zwinkels ()

LSF Research Working Paper Series from Luxembourg School of Finance, University of Luxembourg

Abstract: GARCH-type models have been very successful in describing the volatility dynamics of financial return series for short periods of time. However, for example macroeconomic events may cause the structure of volatility to change and the assumption of stationarity is no longer plausible. In order to deal with this issue, the current paper proposes a conditional volatility model with time varying coefficients based on a multinomial switching mechanism. By giving more weight to either the persistence or shock term in a GARCH model, conditional on their relative ability to forecast a benchmark volatility measure, the switching reinforces the persistent nature of the GARCH model. Estimation of this volatility targeting or VT-GARCH model for Dow 30 stocks indicates that the switching model is able to outperform a number of relevant GARCH setups, both in- and out-of-sample, also without any informational advantages.

Keywords: GARCH; time varying coefficients; multinomial logit (search for similar items in EconPapers)
JEL-codes: C22 G17 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-ecm and nep-ets
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Persistent link: https://EconPapers.repec.org/RePEc:crf:wpaper:09-08

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