Timo Teräsvirta

Properties of three well-known and frequently applied first-order models for modelling and forecasting volatility in daily or weekly financial series such as stock and exchange rate returns are considered. These are the standard Generalized Autoregressive Conditional Heteroskedasticity (GARCH), the Exponential GARCH and the Autoregressive Stochastic Volatility model. The focus is on finding out how well these models are able to reproduce characteristic features of such series, also called stylized facts. These include high kurtosis and a rather low-starting and slowly decaying autocorrelation function of the squared or absolute-valued observations. Another stylized fact is that the autocorrelations of absolute-valued returns raised to a positive power are maximized when this power equals unity. Not unexpectedly, a conclusion that emerges from these considerations, largely based on results on the moment structure of these models, is that none of the models dominates the others when it comes to reproducing stylized facts in typical financial time series.

In this article we derive a parameter constancy test of a stationary vector autoregressive model against the hypothesis that the parameters of the model change smoothly over time. A single structural break is contained in this alternative hypothesis as a special case. The test is a generalization of a single-equation test of a similar hypothesis proposed in the literature. An advantage here is that the asymptotic distribution theory is standard. The performance of the tests is compared to that of generalized Chow-tests and found satisfactory in terms of both size and power.

 In this paper we propose a Lagrange multiplier test for volatility interactions among markets or assets. The null hypothesis is the Constant Conditional Correlation GARCH model in which volatility of an asset is described only through lagged squared innovations and volatility of its own. The alternative hypothesis is an extension of that model in which volatility is modelled as a linear combination not only of its own lagged squared innovations and volatility but also of those in the other equations while keeping the conditional correlation structure constant. This configuration enables us to test for volatility transmissions among variables in the model. Monte Carlo experiments show that the proposed test has satisfactory finite sample properties. The size distortions become negligible when the sample size reaches 2500. The test is applied to pairs of foreign exchange returns and individual stock returns. Results indicate that there seem to be volatility interactions in the pairs considered, and that significant interaction effects typically result from the lagged squared innovations of the other variables.

This paper introduces a new approach for adjusting the diurnal variation in the trade durations. The model considers that durations are multiplicatively decomposed into a deterministic time-of-day and a stochastic component. The parametric structure of the diurnal component allows the duration process to change smoothly over the time-of-day. In addition, a testing framework consisting of Lagrange multiplier tests is proposed for specifying the diurnal component. Our methodology is applied to the IBM transaction durations traded at the New York Stock Exchange.

In this paper we develop a testing and modelling procedure for describing the longterm 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 Terasvirta (2008). 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 the daily returns of the DJIA index covering a period of eighty three years of nancial market history. Two major 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.

In a recent paper, Ding, Granger and Engle (1993) introduced a class of autoregressive conditional heteroskedastic models called Asymmetric Power Autoregressive Conditional Heteroskedastic (A-PARCH) models. The authors showed that this class contains as special cases a large number of well-known ARCH and GARCH models. The A-PARCH model contains a particular power parameter that makes the conditional variance equation nonlinear in parameters. Among other things, Ding, Granger and Engle showed that by letting the power parameter approach zero, the A-PARCH family of models also includes the log-arithmic GARCH model as a special case. Hentschel (1995) defined a slightly extended A-PARCH model and showed that after this extension, the A-PARCH model also contains the exponential GARCH (EGARCH) model of Nelson (1991) as a special case as the power parameter approaches zero. Allowing this to happen in a general A-PARCH model forms a starting-point for our investigation. Applications of the A-PARCH model to return series of stocks and exchange rates have revealed some regularities in the estimated values of the power parameter; see Ding, Granger and Engle (1993), Brooks, Faff, McKenzie and Mitchell (2000) and McKenzie and Mitchell (2002).We add to these results by fitting symmetric first-order PARCH models to return series of 30 most actively traded stocks of the Stockholm Stock Index. Our results agree with the previous ones and suggest that the power parameter lowers the autocorrelations of squared observations compared to the corresponding autocorrelations implied, other things equal, by the standard first-order GARCH model. In the present situation this means estimating the autocorrelation function of the squared observations from the data and comparing that with the corresponding values obtained by plugging the parameter estimates into the theoretical expressions of the autocorrelations. Another example can be found in He and Teräsvirta (1999d). The plan of the paper is as follows. Section 2 defines the class of models of interest and introduces notation. The main theoretical results appear in Section 3. Section 4 contains a comparison of autocorrelation functions of squared observations for different models and Section 5 a discussion of empirical examples. Finally, conclusions appear in Section 6. All proofs can be found in Appendix.

In this article, we derive a set of necessary and sufficient conditions for positivity of the vector conditional variance equation in multivariate GARCH models with explicit modelling of conditional correlation. These models include the constant conditional correlation GARCH model of Bollerslev (1990) and its extensions. Under the new conditions, it is possible to introduce negative volatility spillovers in the model. An empirical example illustrates usefulness of having such conditions in practice.

In this paper, we propose two parametric alternatives to the standard GARCH model. They allow the conditional variance to have a smooth time-varying structure of either additive or multiplicative type. The suggested parameterizations describe both nonlinearity and structural change in the conditional and unconditional variances where the transition between regimes over time is smooth. A modelling strategy for these new time-varying parameter GARCH models is developed. It relies on a sequence of Lagrange multiplier tests, and the adequacy of the estimated models is investigated by Lagrange multiplier type misspecification tests. Finite-sample properties of these procedures and tests are examined by simulation. An empirical application to daily stock returns and another one to daily exchange rate returns illustrate the functioning and properties of our modelling strategy in practice. The results show that the long memory type behaviour of the sample autocorrelation functions of the absolute returns can also be explained by deterministic changes in the unconditional variance.

In this paper a Lagrange multiplier test of the hypothesis that the covariance matrix of a multivariate time series model is constant over time is considered. It is assumed that under the alternative, the error variances are time-varying, whereas the correlations remain constant over time. Under the parameterized alternative hypothesis the variances may change continuously as a function of time or some observable stochastic variables. Small-sample properties of the test statistic are investigated by simulation. The assumption of constant correlations does not appear overly restrictive.