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GARCH Models in Python 2

This document discusses rolling window forecasts for GARCH models in Python. It explains expanding and fixed rolling window forecasts, with the expanding window continuously adding new data points and the fixed window adding new points while dropping old ones. Implementing rolling window forecasts avoids lookback bias and overfitting while allowing the model to adapt to new observations. The optimal window size balances bias from an overly wide window against variance from an overly narrow window.

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119 views

GARCH Models in Python 2

This document discusses rolling window forecasts for GARCH models in Python. It explains expanding and fixed rolling window forecasts, with the expanding window continuously adding new data points and the fixed window adding new points while dropping old ones. Implementing rolling window forecasts avoids lookback bias and overfitting while allowing the model to adapt to new observations. The optimal window size balances bias from an overly wide window against variance from an overly narrow window.

Uploaded by

vis
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Distribution

assumptions
GA RCH MODELS IN P YTH ON

Chelsea Yang
Data Science Instructor
Why make assumptions
Volatility is not directly observable

GARCH model use residuals as volatility shocks


rt = μt + ϵt

Volatility is related to the residuals:


ϵt = σt ∗ ζ(W hiteNoise)

GARCH MODELS IN PYTHON


Standardized residuals
Residual = predicted return - mean return
residuals = ϵt = rt − μt

Standardized residual = residual / return volatility


ϵt
std Resid =
σt

GARCH MODELS IN PYTHON


Residuals in GARCH
gm_std_resid = gm_result.resid / gm_result.conditional_volatility

plt.hist(gm_std_resid, facecolor = 'orange',label = 'standardized residuals')

GARCH MODELS IN PYTHON


Fat tails
Higher probability to observe large (positive or negative) returns than under a normal distribution

GARCH MODELS IN PYTHON


Skewness
Measure of asymmetry of a probability distribution

GARCH MODELS IN PYTHON


Student's t-distribution

ν parameter of a Student's t-distribution indicates its shape

GARCH MODELS IN PYTHON


GARCH with t-distribution
arch_model(my_data, p = 1, q = 1,
mean = 'constant', vol = 'GARCH',
dist = 't')

GARCH MODELS IN PYTHON


GARCH with skewed t-distribution
arch_model(my_data, p = 1, q = 1,
mean = 'constant', vol = 'GARCH',
dist = 'skewt')

GARCH MODELS IN PYTHON


Let's practice!
GA RCH MODELS IN P YTH ON
Mean model
speci cations
GA RCH MODELS IN P YTH ON

Chelsea Yang
Data Science Instructor
Constant mean by default
constant mean: generally works well with most nancial return data

arch_model(my_data, p = 1, q = 1,
mean = 'constant', vol = 'GARCH')

GARCH MODELS IN PYTHON


Zero mean assumption
zero mean: use when the mean has been modeled separately

arch_model(my_data, p = 1, q = 1,
mean = 'zero', vol = 'GARCH')

GARCH MODELS IN PYTHON


Autoregressive mean
AR mean: model the mean as an autoregressive (AR) process

arch_model(my_data, p = 1, q = 1,
mean = 'AR', lags = 1, vol = 'GARCH')

GARCH MODELS IN PYTHON


Let's practice!
GA RCH MODELS IN P YTH ON
Volatility models for
asymmetric shocks
GA RCH MODELS IN P YTH ON

Chelsea Yang
Data Science Instructor
Asymmetric shocks in nancial data
News impact curve:

GARCH MODELS IN PYTHON


Leverage effect
Debt-equity Ratio = Debt / Equity

Stock price goes down, debt-equity ratio goes up

Riskier!

GARCH MODELS IN PYTHON


GJR-GARCH

GARCH MODELS IN PYTHON


GJR-GARCH in Python
arch_model(my_data, p = 1, q = 1, o = 1,
mean = 'constant', vol = 'GARCH')

GARCH MODELS IN PYTHON


EGARCH
A popular option to model asymmetric shocks

Exponential GARCH

Add a conditional component to model the asymmetry in shocks similar to the GJR-GARCH

No non-negative constraints on alpha, beta so it runs faster

GARCH MODELS IN PYTHON


EGARCH in Python
arch_model(my_data, p = 1, q = 1, o = 1,
mean = 'constant', vol = 'EGARCH')

GARCH MODELS IN PYTHON


Which model to use
GJR-GARCH or EGARCH?

Which model is better depends on the data

GARCH MODELS IN PYTHON


Let's practice!
GA RCH MODELS IN P YTH ON
GARCH rolling
window forecast
GA RCH MODELS IN P YTH ON

Chelsea Yang
Data Science Instructor
Rolling window for out-of-sample forecast
An exciting part of nancial modeling: predict the unknown

Rolling window forecast: repeatedly perform model tting and forecast as time rolls forward

GARCH MODELS IN PYTHON


Expanding window forecast
Continuously add new data points to the sample

GARCH MODELS IN PYTHON


Motivations of rolling window forecast
Avoid lookback bias

Less subject to over tting

Adapt forecast to new observations

GARCH MODELS IN PYTHON


Implement expanding window forecast
Expanding window forecast:

for i in range(120):
gm_result = basic_gm.fit(first_obs = start_loc,
last_obs = i + end_loc, disp = 'off')
temp_result = gm_result.forecast(horizon = 1).variance

GARCH MODELS IN PYTHON


Fixed rolling window forecast
New data points are added while old ones are dropped from the sample

GARCH MODELS IN PYTHON


Implement xed rolling window forecast
Fixed rolling window forecast:

for i in range(120):
# Specify rolling window range for model fitting
gm_result = basic_gm.fit(first_obs = i + start_loc,
last_obs = i + end_loc, disp = 'off')
temp_result = gm_result.forecast(horizon = 1).variance

GARCH MODELS IN PYTHON


How to determine window size
Usually determined on a case-by-case basis

Too wide window size: include obsolete data that may lead to high bias

Too narrow window size: exclude relevant data that may lead to higher variance

The optimal window size: trade-off to balance bias and variance

GARCH MODELS IN PYTHON


Let's practice!
GA RCH MODELS IN P YTH ON

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