Introduction

ARCH Model
Garch Models
Forecasting Volatility using Garch Models
Results
Dataset, Software and References

Time Series Analysis of GARCH Models for

Volatality

Sumit Sourabh
Ravi Ranjan Singh
Sheetanshu Gupta
Sahil Singhal

November 12, 2010

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models
introduction
Forecasting Volatility using Garch Models
Results
Dataset, Software and References

Introduction

Financial Time Series such as exchange rates, inflation rates

and stock prices exhibit volatility which varies over time.
Statistically speaking, it means that conditional variance for
the given past or in other words volatility may be
heteroskedastic.
p
σt = Var (Xt |Xt−1 , . . . , X1 )

Engel (1982) modeled this heteroskedasticity by relating

conditional variance of the disturbance term at time t to size
of squared disturbance terms in the past.
Volatality estimation is needed for a lot of applications namely
Option Pricing, Asset Pricing etc.
Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal
Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models
Model Descriptionl
Forecasting Volatility using Garch Models
Results
Dataset, Software and References

ARCH Model

We define the variable ui as the continuously compounded

return during the day which are assumed to be normally
distributed
Si
ui = ln
Si−1
We want an estimate of the σn 2 , the volatility of the market
variable on the nth day.
In order to have a current estimate of volatility we consider
the past m compounded square returns and a long run
average variance rate.

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models
Model Descriptionl
Forecasting Volatility using Garch Models
Results
Dataset, Software and References

ARCH Model
According to the simple Autoregressive Conditionally
Heteroskedastic ARCH(m) model the variance is given by
m
X
2 2
σn = γVL + αi un−i
i=1
m
X
where γ + αi = 1, VL is the long term variance rate , γ
i=1
and αi0 s are the respective weights assigned.
We can use Generalised Least Squares or maximum likelihood
estimation to estimate the ARCH models.
Defining ω = γVL the above equation can be rewritten as
Xm
σn 2 = ω + 2
αi un−i
i=1Series Analysis of GARCH Models for Volatality
Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal
Time
 Introduction
ARCH Model
Garch Models The Garch Model
Forecasting Volatility using Garch Models Estimation of Garch Models
Results
Dataset, Software and References

The Garch Model

The Garch (1,1) model was proposed by Bollerslev in 1986. In

2
case of Garch we also include the past variance rate σn−1
2
when estimating the current vairance σn .
Formally put the equation for a Garch(1,1) model is

σn 2 = γVL + αun−1
2 2
+ βσn−1

where the weights add up to 1 or γ + α + β = 1

The general Garch(p,q) thus is given by
p
X q
X
σn 2 = γVL + 2
αi un−i + 2
βj σn−j
i=1 j=1

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models The Garch Model
Forecasting Volatility using Garch Models Estimation of Garch Models
Results
Dataset, Software and References

Estimation of Garch Models

We consider how Maximum Likelihood method can be used for
estimating the Garch parameters. We assume that probability
distribution of ui conditional on the variance is normal
The Log Likelihood function is given by
m  2
Y 1 −ui
√ exp
2πσi 2σi
i=1
This is same as maximaizing
m 
ui2
X 
−ln(σi ) −
σi
i=1
We use the equation for the garch model and search iteratively
to find the parameters which maximizes the above equation.
Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal
Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models
Forecasting Volatility using Garch Models
Results
Dataset, Software and References

Forecasting Volatility using Garch Models

The volatility estimated used a Garch (1,1) model is
σn 2 = (1 − α − β)VL + αun−1
2 2
+ βσn−1
For estimating the volatality after on (n + t)th day we use the
following
2
E [σn+t 2
− VL ] = αE [un+t−1 − VL ] + βE [σn+t−1 − VL ]
t 2
= (α + β) (E [σn+t−1 − VL ]
Using the above equation repeatedly gives us
2
E [σn+t − VL ] = (α + β)t (σn2 − VL )
or
2
σn+t = VL + (α + β)t (σn2 − VL )
Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal
Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model Plot of returns and log returns
Garch Models Plot of ACF and PACF
Forecasting Volatility using Garch Models The Estimated Model
Results Plot of Estimated Volatalities
Dataset, Software and References

Plot of Returns
We used the end of the day BSE index for the last couple of years

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model Plot of returns and log returns
Garch Models Plot of ACF and PACF
Forecasting Volatility using Garch Models The Estimated Model
Results Plot of Estimated Volatalities
Dataset, Software and References

Plot of log Returns

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model Plot of returns and log returns
Garch Models Plot of ACF and PACF
Forecasting Volatility using Garch Models The Estimated Model
Results Plot of Estimated Volatalities
Dataset, Software and References

Plot of ACF

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model Plot of returns and log returns
Garch Models Plot of ACF and PACF
Forecasting Volatility using Garch Models The Estimated Model
Results Plot of Estimated Volatalities
Dataset, Software and References

Plot of PACF

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model Plot of returns and log returns
Garch Models Plot of ACF and PACF
Forecasting Volatility using Garch Models The Estimated Model
Results Plot of Estimated Volatalities
Dataset, Software and References

The Estimated Model

The estimated GARCH (1,1) model for our case is

σn2 = 4.9687e − 006 + 0.087243un2 + 0.8705σn−1

2

Using estimated model we can predict the future volatalities.

We have the plot of the volatalities on the next slide using the
forecasting method.

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model Plot of returns and log returns
Garch Models Plot of ACF and PACF
Forecasting Volatility using Garch Models The Estimated Model
Results Plot of Estimated Volatalities
Dataset, Software and References

Plot of Estimated Volatalities

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models Dataset and Software
Forecasting Volatility using Garch Models References
Results
Dataset, Software and References

Dataset and Software

The end of day data for the stocks listed in National Stock
exchange is freely available at http:\\finance.yahoo.com.
For estimating the ARCH and GARCH model parameters we
use the MATLAB Garch toolbox which uses iterations to
maximize the maximum likelihood fucntion.

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models Dataset and Software
Forecasting Volatility using Garch Models References
Results
Dataset, Software and References

References

Cambell,John Y., Lo,Andrew W. & Craig, A., The

Econometrics of Financial Markets, Princeton University
Press, 1997.
Engle, R. ,Autorregressive Conditional Heteroskedasticity
with Estimates of United Kingdom Inflation Econometrica, 50,
987-1008, 1982.
Engel, R. GARCH 101: The Use of ARCH/GARCH Models
in Applied Econometrics, Journal of Economic Perspectives
Volume 15, Number 4, 2001.
Bollerslev, T.Generalized Autorregressive Conditional
Heteroskedasticity, Journal of Econometrics, 31, 307-327,1986

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality
 Introduction
ARCH Model
Garch Models Dataset and Software
Forecasting Volatility using Garch Models References
Results
Dataset, Software and References

Thank You

Sumit Sourabh Ravi Ranjan Singh Sheetanshu Gupta Sahil Singhal

Time Series Analysis of GARCH Models for Volatality