Presentation on theme: "Robert Engle and Jose Gonzalo Rangel NYU and UCSD"— Presentation transcript:
1Robert Engle and Jose Gonzalo Rangel NYU and UCSD Spline Garch as a Measure of Unconditional Volatility and its Global Macroeconomic CausesRobert Engle and Jose Gonzalo RangelNYU and UCSD
2GOALS ESTIMATE THE DETERMINANTS OF GLOBAL EQUITY VOLATILITY How are long run volatility forecasts affected by macroeconomic conditions?What volatility can be expected for a newly opened financial market?MEASURE AND MODEL CHANGING UNCONDITIONAL VOLATILITY
3WHAT MOVES ASSET PRICES AND VOLATILITY? NEWS vs OTHER THINGSRESEARCH STRATEGIESVOLATILITY MODELSe.g.Officer(1973), Schwert(1989)ANNOUNCEMENT + NEWS MODELSe.g.Roll(1988), Cutler Poterba and Summers(1990)In all cases, macro effects appear small
4A MODEL CAMPBELL(1991), CAMPBELL& SHILLER(1988) LOG LINEARIZATION Decompose into Innovations to the present discounted value of future dividends or expected returns
5MULTIPLICATIVE EFFECTS The impact of a news event may depend upon the macro economy.Eg. News about a firm will have a bigger effect in a recession or close to bankruptcy
6NEWS EVENTS Return is a function of news times its impact e = observable newsz = macro or deterministic eventsif news is not observable, then there is just an innovation, u
7NEWS VARIANCEThe variance of the news also depends upon macro and other deterministic elements both through the intensity and the magnitude of the news.
8REALIZED VARIANCERealized Variance is the unconditional variance plus an error. Assuming mean zero returns:
9HISTORY OF THE US EQUITY MARKET VOLATILITY: S&P500 PLOT PRICES AND RETURNSHOW MUCH DO RETURNS FLUCTUATE?
14MEAN REVERSION QUOTES “Volatility is Mean Reverting” no controversy“The long run level of volatility is constant”very controversial“Volatility is systematically lower now than it has been in years”Very controversial. Cannot be answered by simple GARCH
15DEFINITIONSrt is a mean zero random variable measuring the return on a financial assetCONDITIONAL VARIANCEUNCONDITIONAL VARIANCE
31PATTERNS OF VOLATILITY ASSET CLASSESEQUITIESEQUITY INDICESCURRENCIESFUTURESINTEREST RATESBONDSPUT TOGETHER AN EVIEWS WORKFILE WITH ALL SIX TYPES OF ASSET CLASSES. FOR THE BONDS USE A LONG BOND YIELD SO THAT PRICE IS COUPON/YIELD. THEN FIGURE OUT RETURN. SIMILARLY FOR SHORT TERM INTEREST RATES – APPROXIMATELY TAKE FIRST DIFFERENCES. SHOULD I THINK ABOUT THE VOLATILITY OF PRICE DIFFERENCES VS LOG DIFFERENCES?
43ESTIMATIONVolatility is regressed against explanatory variables with observations for countries and years.Within a country residuals are auto-correlated due to spline smoothing. Hence use SUR.Volatility responds to global news so there is a time dummy for each year.Unbalanced panel
53CONCLUSIONS AND IMPLICATIONS Unconditional volatility changes in systematic ways.Macro volatility and growth are important determinants of financial volatility.Unconditional volatility and realized volatility give similar results but the former fits better.Big swings in financial volatility are common across the globe.