Merits and drawbacks of variance targeting in GARCH models

Francq, Christian and Horvath, Lajos and Zakoian, Jean-Michel (2009): Merits and drawbacks of variance targeting in GARCH models.

Abstract

Variance targeting estimation is a technique used to alleviate the numerical difficulties encountered in the quasi-maximum likelihood (QML) estimation of GARCH models. It relies on a reparameterization of the model and a first-step estimation of the unconditional variance. The remaining parameters are estimated by QML in a second step. This paper establishes the asymptotic distribution of the estimators obtained by this method in univariate GARCH models. Comparisons with the standard QML are provided and the merits of the variance targeting method are discussed. In particular, it is shown that when the model is misspecified, the VTE can be superior to the QMLE for long-term prediction or Value-at-Risk calculation. An empirical application based on stock market indices is proposed.

• Item Type: MPRA Paper
• Language: English
• Keywords: Consistency and Asymptotic Normality; GARCH; Heteroskedastic Time Series; Quasi Maximum Likelihood Estimation; Value-at-Risk; Variance Targeting Estimator.
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C13 - Estimation: General; C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes

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