TimeSeriesBook.pdf

# In the case of a garch model σ 2 t is given by

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In the case of a GARCH model σ 2 t is given by weighted infinite sum of the Z 2 t - 1 , Z 2 t - 2 , . . . (see the expression (8.9) for σ 2 t in the GARCH(1,1) model). For finite samples, this infinite sum must be approximated by a finite sum 11 The existence of the fourth moment is necessary for the asymptotic normality of the maximum-likelihood estimator, but not for the consistence. It is possible to relax this assumption somewhat (see Hall and Yao (2003)). 12 If ν t is assumed to follow another distribution than the normal, one may use this distribution instead.

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8.3. ESTIMATION OF GARCH(P,Q) MODELS 199 of s summands such that the numbers of summands s is increasing with the sample size.(see Hall and Yao (2003)). We then merge all parameters of the model as follows: φ = ( c, φ 1 , . . . , φ r ) 0 , α = ( α 0 , α 1 , . . . , α p ) 0 and β = ( β 1 , . . . , β q ) 0 . For a given realization x = ( x 1 , x 2 , . . . , x T ) the likelihood function conditional on x , L( φ, α, β | x ), is de- fined as L( φ, α, β | x ) = f ( x 1 , x 2 , . . . , x s - 1 ) T Y t = s f ( x t |X t - 1 ) where in X t - 1 the random variables are replaced by their realizations. The likelihood function can be seen as the probability of observing the data at hand given the values for the parameters. The method of maximum like- lihood then consist in choosing the parameters ( φ, α, β ) such that the like- lihood function is maximized. Thus we chose the parameter so that the probability of observing the data is maximized. In this way we obtain the maximum likelihood estimator. Taking the first s realizations as given de- terministic starting values, we then get the conditional likelihood function . In practice we do not maximize the likelihood function but the logarithm of it where we take f ( x 1 , . . . , x s - 1 ) as a fixed constant which can be neglected in the optimization: log L( φ, α, β | x ) = T X t = s log f ( x t |X t ) = - T 2 log 2 π - 1 2 T X t = s log σ 2 t - 1 2 T X t = s z 2 t σ 2 t where z t = x t - c - φ 1 x t - 1 - . . . - φ r x t - r denotes the realization of Z t . The maximum likelihood estimator is obtained by maximizing the likelihood func- tion over the admissible parameter space. Usually, the implementation of the stationarity condition and the condition for the existence of the fourth mo- ment turns out to be difficult and cumbersome so that often these conditions are neglected and only checked in retrospect or some ad hoc solutions are en- visaged. It can be shown that the (conditional) maximum likelihood estima- tor leads to asymptotically normally distributed estimates. 13 The maximum likelihood estimator remains meaningful even when { ν t } is not normally dis- tributed. In this case the quasi maximum likelihood estimator is obtained (see Hall and Yao (2003) and Fan and Yao (2003)). For numerical reasons it is often convenient to treat the mean equation and the variance equation separately. As the mean equation is a simple 13 Jensen and Rahbek (2004) showed that, at least for the GARCH(1,1) case, the sta- tionarity condition is not necessary.
200 CHAPTER 8. MODELS OF VOLATILITY AR(r) model, it can be estimated by ordinary least-squares (OLS) in a first step. This leads to consistent parameter estimates. However, due to the

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• Spring '17
• Raffaelle Giacomini

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