ARCH- GARCH

Presented by: Amirah Hadi Aqilah (120210140105)

Outline

Why use ARCH GARCH?

Models
How to Conduct ARCH GARCH on STATA
Why use ARCH GARCH?

Heteroskedasticity Problem
(Variance is not constant)
ARCH GARCH MODEL
 ARCH GARCH

Yt 0 pYt p et (Conditional Mean) Yt 0 pYt p pet p et (Conditional Mean)

2 t w 1e 2 t p Vt (Conditional Variance) 2 t w 1e 2 t p 2 2 t 1 Vt (Conditional Variance)

It's an AR model with conditional It models the variance itself with an AR mode
heteroskedacity (conditional on the
current time)
 ARCH in Mean ARCH with ARMA Process

Usually use to determine risk and return Seasonal Data

of an investment

Yt 0 pYt p p 2 t et (Conditional Mean) Yt 0 pYt p 0et 1 1et 4 et (Conditional Mean)

2 t w 1e 2 t p Vt (Conditional Variance) 2 t w 1e 2 t p Vt (Conditional Variance)
 EGARCH

Yt 0 pYt p 0et 1 1et 4 et (Conditional Mean)

et 1 et 1 2
ln( t ) w 1
2

2 2 3 t 1 Vt (Conditional Variance)
2

2 t 1
t 1

EARC EGARCH
EARCH-A
H

EGARCH is used to explore the response of fluctuations in

a data
HOW TO CONDUCT ARCH GARCH
ON STATA
Step 1: Correlogram Check
. corrgram missouri

-1 0 1 -1 0 1
Command: LAG AC PAC Q Prob>Q [Autocorrelation] [Partial Autocor]

1 0.9930 0.9937 310.59 0.0000

Corrgram variable 2
3
0.9807
0.9652
-0.3963
-0.1436
614.55
909.93
0.0000
0.0000
4 0.9456 -0.2304 1194.3 0.0000

It is to see which model suit our 5

6
0.9237
0.9001
0.0198
-0.0327
1466.6
1726
0.0000
0.0000
7 0.8746 -0.0392 1971.6 0.0000
data best, by looking at the ACF 8 0.8481 0.0479 2203.5 0.0000
9 0.8205 -0.0423 2421.1 0.0000
and PACF 10
11
0.7921
0.7641
0.0124
0.0330
2624.7
2814.7
0.0000
0.0000
12 0.7381 0.1451 2992.6 0.0000
13 0.7145 0.0983 3159.8 0.0000
14 0.6915 -0.1357 3317 0.0000
15 0.6695 -0.0415 3464.9 0.0000
16 0.6496 0.0761 3604.6 0.0000
The ACF is geometric and PACF 17
18
0.6300
0.6108
-0.0932
-0.0334
3736.4
3860.7
0.0000
0.0000
only significant till P lags: AR 19
20
0.5922
0.5741
-0.0316
0.0681
3977.9
4088.5
0.0000
0.0000
model 21
22
0.5565
0.5391
-0.0195
-0.0259
4192.8
4291
0.0000
0.0000
23 0.5216 0.0183 4383.2 0.0000
24 0.5042 0.0149 4469.7 0.0000
25 0.4875 0.1085 4550.8 0.0000
26 0.4711 -0.0312 4626.8 0.0000
27 0.4540 -0.0710 4697.7 0.0000
28 0.4371 -0.0186 4763.6 0.0000
29 0.4201 -0.0628 4824.7 0.0000
30 0.4021 -0.0646 4880.9 0.0000
31 0.3831 -0.0547 4932.1 0.0000
32 0.3636 0.0325 4978.3 0.0000
33 0.3431 -0.0930 5019.7 0.0000
34 0.3223 0.0462 5056.3 0.0000
35 0.3017 0.0632 5088.5 0.0000
36 0.2810 0.0618 5116.5 0.0000
37 0.2609 0.0342 5140.8 0.0000
38 0.2413 -0.0113 5161.6 0.0000
39 0.2222 0.0047 5179.3 0.0000
40 0.2035 -0.0235 5194.2 0.0000
Step 2: Dickey Fuller Test
To check whether the variable . dfuller missouri
used is stationary or not.
Dickey-Fuller test for unit root Number of obs = 311
Command: dfuller variablename
Interpolated Dickey-Fuller
dfuller d. variablename Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -0.957 -3.455 -2.878 -2.570

Ho: The Variable has Unit Root
MacKinnon approximate p-value for Z(t) = 0.7688
or Not Stationary
Ha: The Variable doesnt have . dfuller d.missouri

Unit Root or Stationary Dickey-Fuller test for unit root Number of obs = 310

Criteria: Interpolated Dickey-Fuller

Test 1% Critical 5% Critical 10% Critical
P value < Ho is rejected Statistic Value Value Value

If its not stationary, treat it by Z(t) -11.613 -3.455 -2.878 -2.570

differencing the variable MacKinnon approximate p-value for Z(t) = 0.0000

Step 3: Regress the variable(s)
. reg d.tenn l.d.tenn l.d.missouri l.d.kentucky
Regress the variable(s) which is
already stationary to its own in Source SS df MS Number of obs = 310
the previouse period. F( 3, 306) = 16.93
Model 1.3724348 3 .457478268 Prob > F = 0.0000
Command: reg variablename Residual 8.26743709 306 .027017768 R-squared = 0.1424
l.variablename Adj R-squared = 0.1340
Total 9.63987189 309 .031196996 Root MSE = .16437

D.tenn Coef. Std. Err. t P>|t| [95% Conf. Interval]

tenn
LD. .2673303 .0613879 4.35 0.000 .1465345 .3881261

missouri
LD. .1690822 .0549519 3.08 0.002 .0609509 .2772135

kentucky
LD. .0204143 .0505356 0.40 0.687 -.079027 .1198556

_cons -.0002101 .0093371 -0.02 0.982 -.0185831 .018163

Step 4: ARCH Test
This is to check whether the
. estat archlm
model is heteroskedastic or not. LM test for autoregressive conditional heteroskedasticity (ARCH)

lags(p) chi2 df Prob > chi2

Command: estat archlm, lags
1 8.493 1 0.0036
(1/2)
Ho: The Variable(s) doesnt have H0: no ARCH effects vs. H1: ARCH(p) disturbance

heteroskedasticity problem or No . estat archlm, lags (2)

ARCH Effect LM test for autoregressive conditional heteroskedasticity (ARCH)

Ho: The Variable(s) has lags(p) chi2 df Prob > chi2

heteroskedasticity problem or
ARCH Effect Exists 2 9.850 2 0.0073

Criteria: H0: no ARCH effects vs. H1: ARCH(p) disturbance

p.value < Ho is rejected

Step 5: Treat the Model ARCH/GARCH Model
Because we encountered ARCH family regression

heteroskedasticity problem, we need Sample: 1978m3 - 2003m12 Number of obs = 310

to treat the model. Distribution: Gaussian Wald chi2(3) = 50.98
Log likelihood = 126.1584 Prob > chi2 = 0.0000
Command:
ARCH: arch variablename OPG
D.tenn Coef. Std. Err. z P>|z| [95% Conf. Interval]
l.variablename, arch (1)
tenn
GARCH: arch variablename tenn
l.variablename, arch (1) garch (1) LD. .2977368 .0636429 4.68 0.000 .1729991 .4224746

ARCH-M: arch variablename missouri

LD. .1873854 .0528514 3.55 0.000 .0837986 .2909721
l.variablename, archm arch (1)
kentucky
ARCH with ARMA Process: arch LD. -.0342376 .0501626 -0.68 0.495 -.1325545 .0640793
variablename, ar (1) ma (1 4) arch (1)
_cons -.003234 .009188 -0.35 0.725 -.0212421 .0147741
garch (1)
ARCH
EGARCH: arch variablename, ar (1) arch
ma (1 4) earch (1) egarch (1) L1. .1885721 .0906094 2.08 0.037 .010981 .3661633

_cons .0216823 .0020009 10.84 0.000 .0177606 .025604

Step 6: Variance Check
Check whether the
heteroskedasticity problem is . predict v, variance
already treated or not.
. dfuller v
Command:
Dickey-Fuller test for unit root Number of obs = 311
Predict v, variance
Interpolated Dickey-Fuller
Dfuller, v Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -14.472 -3.455 -2.878 -2.570

MacKinnon approximate p-value for Z(t) = 0.0000