Regime Dependent Conditional Volatility in the U.S. Equity Market

33 Pages Posted: 30 Aug 2006

See all articles by Larry Bauer

Larry Bauer

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Date Written: August 28, 2006

Abstract

This study develops the Regime Dependent Generalized Auto Regressive Conditional Heteroskedasticity (RD-GARCH) model and applies it to a daily index of returns on U.S. equities covering the period 1926 to 2000. The RD-GARCH model is different from previous models from the ARCH family in that it combines the ARCH methodology with a general approach that allows model parameters to vary across periods or regimes of differing unconditional volatility.

Likelihood ratio tests of the within-sample properties of the RD-GARCH methodology demonstrate superiority of the model over a variety of conventional (G)ARCH models, both for the full sample period and for a number of sub-periods.

The results of this study indicate that combining a model which allows conditional volatility to change in an evolutionary manner with a model which allows for abrupt changes in unconditional volatility at discrete points in time provides a significant improvement over previously available models.

Keywords: ARCH/GARCH, Regime Dependent, Time Series, Conditional Volatility, Likelihood Ratio

JEL Classification: C22, C49, C51, C52, G00

Suggested Citation

Bauer, Larry, Regime Dependent Conditional Volatility in the U.S. Equity Market (August 28, 2006). Available at SSRN: https://ssrn.com/abstract=927044 or http://dx.doi.org/10.2139/ssrn.927044

Larry Bauer (Contact Author)

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, NL A1B 3X5
Canada
709-864-8512 (Phone)

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