What good is a volatility model?

Authors: R.F. Engle; A.J. Patton

Source: Quantitative Finance, Volume 1, Number 2, February 01, 2001 , pp. 237-245(9)

Publisher: Routledge, part of the Taylor & Francis Group

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Abstract:

A volatility model must be able to forecast volatility; this is the central requirement in almost all financial applications. In this paper we outline some stylized facts about volatility that should be incorporated in a model: pronounced persistence and mean-reversion, asymmetry such that the sign of an innovation also affects volatility and the possibility of exogenous or pre-determined variables influencing volatility. We use data on the Dow Jones Industrial Index to illustrate these stylized facts, and the ability of GARCH-type models to capture these features. We conclude with some challenges for future research in this area.

Document Type: Research article

Publication date: 2001-02-01