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What good is a volatility model?

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  • R. F. Engle
  • A. J. Patton

Abstract

A volatility model must be able to forecast volatility; this is the central requirement in almost all financial applications. In this paper we outline some stylized facts about volatility that should be incorporated in a model: pronounced persistence and mean-reversion, asymmetry such that the sign of an innovation also affects volatility and the possibility of exogenous or pre-determined variables influencing volatility. We use data on the Dow Jones Industrial Index to illustrate these stylized facts, and the ability of GARCH-type models to capture these features. We conclude with some challenges for future research in this area.

Suggested Citation

  • R. F. Engle & A. J. Patton, 2001. "What good is a volatility model?," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 237-245.
    • Handle: RePEc:taf:quantf:v:1:y:2001:i:2:p:237-245
    DOI: 10.1088/1469-7688/1/2/305
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