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The Spline-GARCH Model for Low-Frequency Volatility and Its Global Macroeconomic Causes

The Spline-GARCH Model for Low-Frequency Volatility and Its Global Macroeconomic Causes Twenty-five years of volatility research has left the macroeconomic environment playing a minor role. This paper proposes modeling equity volatilities as a combination of macro- economic effects and time series dynamics. High-frequency return volatility is specified to be the product of a slow-moving component, represented by an exponential spline, and a unit GARCH. This slow-moving component is the low-frequency volatility, which in this model coincides with the unconditional volatility. This component is estimated for nearly 50 countries over various sample periods of daily data. Low-frequency volatility is then modeled as a function of macroeconomic and financial variables in an unbalanced panel with a variety of dependence structures. It is found to vary over time and across countries. The low-frequency component of volatility is greater when the macroeconomic factors of GDP, inflation, and short-term interest rates are more volatile or when inflation is high and output growth is low. Volatility is higher not only for emerging markets and markets with small numbers of listed companies and market capitalization relative to GDP, but also for large economies. The model allows long horizon forecasts of volatility to depend on macroeconomic developments, and delivers estimates of the volatility to be anticipated in a newly opened market. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

The Spline-GARCH Model for Low-Frequency Volatility and Its Global Macroeconomic Causes

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Publisher
Oxford University Press
Copyright
© The Author 2008. Published by Oxford University Press on behalf of the Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.
Subject
Articles
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhn004
Publisher site
See Article on Publisher Site

Abstract

Twenty-five years of volatility research has left the macroeconomic environment playing a minor role. This paper proposes modeling equity volatilities as a combination of macro- economic effects and time series dynamics. High-frequency return volatility is specified to be the product of a slow-moving component, represented by an exponential spline, and a unit GARCH. This slow-moving component is the low-frequency volatility, which in this model coincides with the unconditional volatility. This component is estimated for nearly 50 countries over various sample periods of daily data. Low-frequency volatility is then modeled as a function of macroeconomic and financial variables in an unbalanced panel with a variety of dependence structures. It is found to vary over time and across countries. The low-frequency component of volatility is greater when the macroeconomic factors of GDP, inflation, and short-term interest rates are more volatile or when inflation is high and output growth is low. Volatility is higher not only for emerging markets and markets with small numbers of listed companies and market capitalization relative to GDP, but also for large economies. The model allows long horizon forecasts of volatility to depend on macroeconomic developments, and delivers estimates of the volatility to be anticipated in a newly opened market.

Journal

The Review of Financial StudiesOxford University Press

Published: May 28, 2008

Keywords: JEL Classification C14 C22 G10 G15 E44

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