Scribd
Upload
27 views7 pages

Scribd

1. The autoregressive conditional heteroskedasticity (ARCH) model describes the variance of errors in a time series as a function of previous errors. 2. ARCH models are commonly used to model financial time series that exhibit changing volatility and clustering of volatility. 3. If an autoregressive moving average (ARMA) model is assumed for the error variance, the model is a generalized autoregressive conditional heteroskedasticity (GARCH) model, which includes lagged error and variance terms.

Uploaded by

Shlap Lentila
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as TXT, PDF, TXT or read online on Scribd
27 views7 pages

Scribd

1. The autoregressive conditional heteroskedasticity (ARCH) model describes the variance of errors in a time series as a function of previous errors. 2. ARCH models are commonly used to model financial time series that exhibit changing volatility and clustering of volatility. 3. If an autoregressive moving average (ARMA) model is assumed for the error variance, the model is a generalized autoregressive conditional heteroskedasticity (GARCH) model, which includes lagged error and variance terms.

Uploaded by

Shlap Lentila
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as TXT, PDF, TXT or read online on Scribd
You are on page 1/ 7

From Wikipedia, the free encyclopedia

"ARCH" redirects here. For other uses, see Arch (disambiguation).


In econometrics, the autoregressive conditional heteroskedasticity (ARCH) model is
a statistical model for time series data that describes the variance of the current
error term or innovation as a function of the actual sizes of the previous time
periods' error terms;[1] often the variance is related to the squares of the
previous innovations. The ARCH model is appropriate when the error variance in a
time series follows an autoregressive (AR) model; if an autoregressive moving
average (ARMA) model is assumed for the error variance, the model is a generalized
autoregressive conditional heteroskedasticity (GARCH) model.[2]

ARCH models are commonly employed in modeling financial time series that exhibit
time-varying volatility and volatility clustering, i.e. periods of swings
interspersed with periods of relative calm. ARCH-type models are sometimes
considered to be in the family of stochastic volatility models, although this is
strictly incorrect since at time t the volatility is completely pre-determined
(deterministic) given previous values.[3]

Model specification
To model a time series using an ARCH process, let

�
�

~\epsilon _{t}~denote the error terms (return residuals, with respect to a mean
process), i.e. the series terms. These

�
�

~\epsilon _{t}~ are split into a stochastic piece


�
�
z_{t} and a time-dependent standard deviation
�
�
\sigma _{t} characterizing the typical size of the terms so that

�
�
=
�
�
�
�

~\epsilon _{t}=\sigma _{t}z_{t}~


The random variable
�
�
z_{t} is a strong white noise process. The series
�
�
2
\sigma _{t}^{2} is modeled by

�
�
2
=
�
0
+
�
1
�
�
−
1
2
+
⋯
+
�
�
�
�
−
�
2
=
�
0
+
∑
�
=
1
�
�
�
�
�
−
�
2
\sigma _{t}^{2}=\alpha _{0}+\alpha _{1}\epsilon _{{t-1}}^{2}+\cdots +\alpha _{q}\
epsilon _{{t-q}}^{2}=\alpha _{0}+\sum _{{i=1}}^{q}\alpha _{{i}}\epsilon _{{t-
i}}^{2},
where

�
0
>
0

~\alpha _{0}>0~ and


�
�
≥
0
,

�
>
0
\alpha _{i}\geq 0,~i>0.
An ARCH(q) model can be estimated using ordinary least squares. A method for
testing whether the residuals
�
�
{\displaystyle \epsilon _{t}} exhibit time-varying heteroskedasticity using the
Lagrange multiplier test was proposed by Engle (1982). This procedure is as
follows:

Estimate the best fitting autoregressive model AR(q)


�
�
=
�
0
+
�
1
�
�
−
1
+
⋯
+
�
�
�
�
−
�
+
�
�
=
�
0
+
∑
�
=
1
�
�
�
�
�
−
�
+
�
�
y_{t}=a_{0}+a_{1}y_{{t-1}}+\cdots +a_{q}y_{{t-q}}+\epsilon _{t}=a_{0}+\sum
_{{i=1}}^{q}a_{i}y_{{t-i}}+\epsilon _{t}.
Obtain the squares of the error
�
^
2
{\hat \epsilon }^{2} and regress them on a constant and q lagged values:
�
^
�
2
=
�
^
0
+
∑
�
=
1
�
�
^
�
�
^
�
−
�
2
{\hat \epsilon }_{t}^{2}={\hat \alpha }_{0}+\sum _{{i=1}}^{{q}}{\hat \
alpha }_{i}{\hat \epsilon }_{{t-i}}^{2}
where q is the length of ARCH lags.
The null hypothesis is that, in the absence of ARCH components, we have
�
�
=
0
\alpha _{i}=0 for all
�
=
1
,
⋯
,
�
i=1,\cdots ,q. The alternative hypothesis is that, in the presence of ARCH
components, at least one of the estimated
�
�
\alpha _{i} coefficients must be significant. In a sample of T residuals under the
null hypothesis of no ARCH errors, the test statistic T'R² follows
�
2
\chi ^{2} distribution with q degrees of freedom, where
�
′
T' is the number of equations in the model which fits the residuals vs the lags
(i.e.
�
′
=
�
−
�
T'=T-q). If T'R² is greater than the Chi-square table value, we reject the null
hypothesis and conclude there is an ARCH effect in the ARMA model. If T'R² is
smaller than the Chi-square table value, we do not reject the null hypothesis.
GARCH
If an autoregressive moving average model (ARMA) model is assumed for the error
variance, the model is a generalized autoregressive conditional heteroskedasticity
(GARCH) model.[2]

In that case, the GARCH (p, q) model (where p is the order of the GARCH terms

�
2
~\sigma ^{2} and q is the order of the ARCH terms

�
2
~\epsilon ^{2} ), following the notation of the original paper, is given by

�
�
=
�
�
′
�
+
�
�
{\displaystyle y_{t}=x'_{t}b+\epsilon _{t}}

�
�
|
�
�
−
1
∼
�
(
0
,
�
�
2
)
{\displaystyle \epsilon _{t}|\psi _{t-1}\sim {\mathcal {N}}(0,\sigma _{t}^{2})}

�
�
2
=
�
+
�
1
�
�
−
1
2
+
⋯
+
�
�
�
�
−
�
2
+
�
1
�
�
−
1
2
+
⋯
+
�
�
�
�
−
�
2
=
�
+
∑
�
=
1
�
�
�
�
�
−
�
2
+
∑
�
=
1
�
�
�
�
�
−
�
2
{\displaystyle \sigma _{t}^{2}=\omega +\alpha _{1}\epsilon _{t-1}^{2}+\cdots +\
alpha _{q}\epsilon _{t-q}^{2}+\beta _{1}\sigma _{t-1}^{2}+\cdots +\beta _{p}\sigma
_{t-p}^{2}=\omega +\sum _{i=1}^{q}\alpha _{i}\epsilon _{t-i}^{2}+\sum _{i=1}^{p}\
beta _{i}\sigma _{t-i}^{2}}

Generally, when testing for heteroskedasticity in econometric models, the best test
is the White test. However, when dealing with time series data, this means to test
for ARCH and GARCH errors.

Exponentially weighted moving average (EWMA) is an alternative model in a separate


class of exponential smoothing models. As an alternative to GARCH modelling it has
some attractive properties such as a greater weight upon more recent observations,
but also drawbacks such as an arbitrary decay factor that introduces subjectivity
into the estimation.

GARCH(p, q) model specification


The lag length p of a GARCH(p, q) process is established in three steps:

You might also like