SIGN- AND VOLATILITY-SWITCHING ARCH MODELS: THEORY AND APPLICATIONS TO INTERNATIONAL STOCK MARKETS

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130 citations0/0 files storedJournal of Applied Econometrics

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Financial Risk and Volatility Modeling Stochastic processes and financial applications Market Dynamics and Volatility

Abstract

This paper develops two conditionally heteroscedastic models which allow an asymmetric reaction of the conditional volatility to the arrival of news. Such a reaction is induced by both the sign of past shocks and the size of past unexpected volatility. The proposed models are shown to converge in distribution to absolutely continuous Itô diffusion processes, as happens for other heteroscedastic formulations. One of the schemes developed in the paper—the Volatility-switching ARCH—differs from the existing asymmetric models insofar as it is able to capture a particular aspect of the behaviour of the volatilities, i.e. the reversion of their asymmetric reaction to news. Empirical evidence from stock market returns in six countries shows that such a model outperforms traditional asymmetric ARCH equations. © 1997 by John Wiley & Sons, Ltd.

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References

1986Generalized autoregressive conditional heteroskedasticity 1982Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation 1958The Cost of Capital, Corporation Finance and the Theory of Investment 1991Conditional Heteroskedasticity in Asset Returns: A New Approach 1993On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks 1997The variation of certain speculative prices 1992ARCH modeling in finance 1987The Pricing of Options on Assets with Stochastic Volatilities

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