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Modelling Time-Varying Volatility Interactions

Author

Listed:
  • Susana Campos-Martins

    (University of Oxford, University of Minho and NIPE)

  • Cristina Amado

    (University of Minho and NIPE, CREATES and Aarhus University)

Abstract

In this paper, we propose an additive time-varying (or partially time-varying) multivariate model of volatility, where a time-dependent component is added to the extended vector GARCH process for modelling the dynamics of volatility interactions. In our framework, co-dependence in volatility is allowed to change smoothly between two extreme states and second-moment interdependence is identified from these crisis-contingent strucural changes. The estimation of the new time-varying vector GARCH process is simplified using an equation-by-equation estimator for the volatility equations in the first step, and estimating the correlation matrix in the second step. A new Lagrange multiplier test is derived for testing the null hypothesis of constancy co-dependence volatility against a smoothly time-varying interdependence between financial markets. The test appears to be a useful statistical tool for evaluating the adequacy of GARCH equations by testing the presence of significant changes in cross-market volatility transmissions. Monte Carlo simulation experiments show that the test statistic has satisfactory empirical properties in finite samples. An application to sovereign bond yield returns illustrates the modelling strategy of the new specification.

Suggested Citation

  • Susana Campos-Martins & Cristina Amado, 2021. "Modelling Time-Varying Volatility Interactions," NIPE Working Papers 12/2021, NIPE - Universidade do Minho.
    • Handle: RePEc:nip:nipewp:12/2021
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    File URL: http://repositorium.sdum.uminho.pt/handle/1822/74381
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    More about this item

    Keywords

    Multivariate time-varying GARCH; Volatility spillovers; Time-variation; Lagrange multiplier test; Financial market interdependence.;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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