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Working Paper 1994-015B

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"Markov Switching in GARCH Processes and Mean Reverting Stock Market Volatility"
by Michael J. Dueker

This paper introduces four models of conditional heteroscedasticity that contain markov switching parameters to examine their multi-period stock-market volatility forecasts as predictions of options-implied volatilities. The volatility model that best predicts the behavior of the optionsimplied volatilities allows the student-t degrees-of-freedom parameter to switch such that the conditional variance and kurtosis are subject to discrete shifts. The half-life of the most leptokurtic state is estimated to be weak, so expected market volatility reverts to near-normal levels fairly quickly following a spike.

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Category > Applied Econometrics
Category > Finance
Author > Michael J. Dueker