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The relation between conditionally heteroskedastic factor models and factor GARCH models

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  • ENRIQUE SENTANA

Abstract

The factor GARCH model of Engle (1987) and the latent factor ARCH model of Diebold and Nerlove (1989) have become rather popular multivariate volatility parametriza-tions due to their parsimony, and the commonality in volatility movements across different financial series. Nevertheless, there is some confusion in the literature between them. The purpose of this paper is to make clear their similarities and differences by providing a formal nesting of the two models, which can be exploited to analyse their statistical features in a more general context. At the same time, their differences may be important in the interpretation of empirical results.

Suggested Citation

  • Enrique Sentana, 1998. "The relation between conditionally heteroskedastic factor models and factor GARCH models," Econometrics Journal, Royal Economic Society, vol. 1(RegularPa), pages 1-9.
    • Handle: RePEc:ect:emjrnl:v:1:y:1998:i:regularpapers:p:1-9
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    1. Sentana, Enrique & Fiorentini, Gabriele, 2001. "Identification, estimation and testing of conditionally heteroskedastic factor models," Journal of Econometrics, Elsevier, vol. 102(2), pages 143-164, June.
    2. Aaron Smith, 2005. "Partially overlapping time series: a new model for volatility dynamics in commodity futures," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 20(3), pages 405-422.
    3. Catherine Doz & Eric Renault, 2004. "Conditionaly Heteroskedastic Factor Models : Identificationand Instrumental variables Estmation," THEMA Working Papers 2004-13, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    4. Silvennoinen, Annastiina & Teräsvirta, Timo, 2007. "Multivariate GARCH models," SSE/EFI Working Paper Series in Economics and Finance 669, Stockholm School of Economics, revised 18 Jan 2008.
    5. Antonis Demos & George Vasillelis, 2007. "U.K. Stock Market Inefficiencies and the Risk Premium," Multinational Finance Journal, Multinational Finance Journal, vol. 11(1-2), pages 97-122, March-Jun.
    6. Lucia Alessi & Matteo Barigozzi & Marco Capasso, 2006. "Generalized Dynamic Factor Model + GARCH Exploiting Multivariate Information for Univariate Prediction," LEM Papers Series 2006/13, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    7. Giorgio Calzolari & F. Di Iorio & G. Fiorentini, 1999. "Indirect Estimation of Just-Identified Models with Control Variates," Econometrics Working Papers Archive quaderno46, Universita' degli Studi di Firenze, Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti".
    8. Mohamed Saidane & Christian Lavergne, 2009. "Optimal Prediction with Conditionally Heteroskedastic Factor Analysed Hidden Markov Models," Computational Economics, Springer;Society for Computational Economics, vol. 34(4), pages 323-364, November.
    9. Fiorentini, Gabriele & Galesi, Alessandro & Sentana, Enrique, 2018. "A spectral EM algorithm for dynamic factor models," Journal of Econometrics, Elsevier, vol. 205(1), pages 249-279.
    10. Antonis Demos & Sofia Parissi, 1998. "Testing Asset Pricing Models: The Case of Athens Stock Exchange," Multinational Finance Journal, Multinational Finance Journal, vol. 2(3), pages 189-223, September.
    11. Barigozzi, Matteo & Brownlees, Christian & Gallo, Giampiero M. & Veredas, David, 2014. "Disentangling systematic and idiosyncratic dynamics in panels of volatility measures," Journal of Econometrics, Elsevier, vol. 182(2), pages 364-384.
    12. Gabriele Fiorentini & Enrique Sentana & Neil Shephard, 2004. "Likelihood-Based Estimation of Latent Generalized ARCH Structures," Econometrica, Econometric Society, vol. 72(5), pages 1481-1517, September.
    13. Sébastien Laurent & Luc Bauwens & Jeroen V. K. Rombouts, 2006. "Multivariate GARCH models: a survey," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 79-109.
    14. Fabrizio Cipollini & Giampiero M. Gallo & Alessandro Palandri, 2020. "A dynamic conditional approach to portfolio weights forecasting," Papers 2004.12400, arXiv.org.
    15. Elena Andreou & Eric Ghysels, 2002. "Tests for Breaks in the Conditional Co-movements of Asset Returns," CIRANO Working Papers 2002s-59, CIRANO.
    16. Klaassen, F.J.G.M., 1999. "Have Exchange Rates Become More Closely Tied? Evidence from a New Multivariate GARCH Model," Discussion Paper 1999-10, Tilburg University, Center for Economic Research.
    17. Enrique Sentana & Gabriele Fiorentini, 1997. "Identification, Estimation and Testing of Conditionally Heteroskedastic Factor Models.Versión Revisada," Working Papers wp1997_9709, CEMFI.
    18. Engle, Robert F. & Marcucci, Juri, 2006. "A long-run Pure Variance Common Features model for the common volatilities of the Dow Jones," Journal of Econometrics, Elsevier, vol. 132(1), pages 7-42, May.
    19. Mondher Bellalah & Marc Lavielle, 2002. "A Decomposition of Empirical Distributions with Applications to the Valuation of Derivative Assets," Multinational Finance Journal, Multinational Finance Journal, vol. 6(2), pages 99-130, June.
    20. Enrique Sentana & Giorgio Calzolari & Gabriele Fiorentini, 2004. "Indirect Estimation of Conditionally Heteroskedastic Factor Models," Working Papers wp2004_0409, CEMFI.
    21. Connor, Gregory & Korajczyk, Robert A. & Linton, Oliver, 2006. "The common and specific components of dynamic volatility," Journal of Econometrics, Elsevier, vol. 132(1), pages 231-255, May.
    22. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Ebens, Heiko, 2001. "The distribution of realized stock return volatility," Journal of Financial Economics, Elsevier, vol. 61(1), pages 43-76, July.
    23. Cipollini, Fabrizio & Gallo, Giampiero M. & Palandri, Alessandro, 2021. "A dynamic conditional approach to forecasting portfolio weights," International Journal of Forecasting, Elsevier, vol. 37(3), pages 1111-1126.

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    More about this item

    Keywords

    Asset pricing; Factor models; Multivariate ARCH; Volatility.;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling

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