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Business Analytics

Specification and Testing of Multiplicative Time-Varying GARCH Models with Applications

Prof. Timo Terasvirta, Department of Economics and Business; Aarhus University

7th Apr 2014  01:00 pm - Merewether Rm 498

In this paper we develop a specification technique for building multiplicative time-varying GARCH models of Amado and Ter┬┐┬┐svirta (2008, 2013). The variance is decomposed into an unconditional and a conditional component such that the unconditional variance component is allowed to evolve smoothly over time. This nonstationary component is defined as a linear combination of logistic transition functions with time as the transition variable. The appropriate number of transition functions is determined by applying a sequence of specification tests. For that purpose, a coherent modelling strategy based on statistical inference is presented. It is heavily dependent on Lagrange multiplier type misspecification tests. The tests are easily implemented as they are entirely based on auxiliary regressions. Finite-sample properties of the strategy and tests are examined by Monte Carlo simulations. The modelling strategy is illustrated in practice with two real examples, an empirical application to daily exchange rate returns and another one to daily coffee futures returns.

* joint work with Cristina Amado