Robustness of the GARCH Model

Follow us on LinkedIn

The generalized autoregressive conditional heteroskedasticity (GARCH) model is an econometric model for analyzing stock market volatility. The GARCH model is used to estimate the variance of a return, using past returns as an input into a model. It is a popular tool for measuring risk in financial markets, as it can capture the time-varying nature of risk.

There is a large volume of literature that deals with the application of the GARCH model in trading. Reference [1] stood out by bringing a new perspective. It examined the robustness of the GARCH model by asking the following questions,

  1. Which rolling GARCH specification produces the most accurate volatility forecast?
  2. Does more frequent model refitting improve portfolio Information Ratio?
  3. How does the size of the training window affect the strategy performance?
  4. Is the base model strategy performance stable with regards to different historical volatility estimators?

After several sensitivity tests, the authors concluded,

Referring to the main hypothesis we can say that we were not able to obtain robust abnormal returns with comparison to the equity benchmark strategies. Further empirical findings support this statement. We found out that (see Table 8) across four GARCH model specifications considered, the strategy based on the threshold GARCH (fGARCH – TGARCH extension) was the most attractive one producing the highest value of Information Ratio, the highest annualized returns and the lowest maximum drawdown. … The more frequent model refitting did not improve portfolio’s Information Ratio – not as it was initially expected. Regarding the size of the training window, we were unable to conclude that the longer or shorter one necessarily improves or diminishes Information Ratio. In our research based on the data used we obtained that there is no direct relationship – and the optimal training window size is within 126 and 252 trading days range. The performance of strategies under different volatility estimators differ considerably. The poor performance of the Garman-Klass and Parkinson estimators might be partially explained by relatively higher number of long signals generated during the overall seven-year downward volatility trend observed.

In short, the performance of the GARCH model is sensitive to system parameters and the length of historical data.

In our opinion, this article tackled a very important question in trading system design, which is robustness.

References

[1]  Oleh Bilyk, Paweł Sakowskia, Robert Ślepaczuka, Investing in VIX futures based on rolling GARCH models forecasts, University of Warsaw, Faculty of Economic Sciences, 2020

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSThe South Park stock market jinx could be coming for high-flying weight-loss stocks
The South Park stock market jinx could be coming for high-flying weight-loss stocks

An analysis found that a stock underperformed the S&P 500 by a median of 7% in the year after being featured in the animated comedy.

Stay up-to-date with the latest news - click here
LATEST NEWSEarnings call: CollPlant reports Q1 2024 results and corporate updates
Earnings call: CollPlant reports Q1 2024 results and corporate updates
Stay up-to-date with the latest news - click here
LATEST NEWSEarnings call: Covalon turns profitable with strong Q2 performance
Earnings call: Covalon turns profitable with strong Q2 performance
Stay up-to-date with the latest news - click here
LATEST NEWSUS health insurer shares fall after UnitedHealth flags Medicaid enrollment issues
US health insurer shares fall after UnitedHealth flags Medicaid enrollment issues
Stay up-to-date with the latest news - click here
LATEST NEWSBESREMi ® (Ropeginterferon alfa-2B) Shows Greatest Benefit Among Cytoreductive Therapies in Lowering Symptomatic Burden of Polycythemia Vera (PV): Real-World Analysis Published at ASCO
BESREMi ® (Ropeginterferon alfa-2B) Shows Greatest Benefit Among Cytoreductive Therapies in Lowering Symptomatic Burden of Polycythemia Vera (PV): Real-World Analysis Published at ASCO
Stay up-to-date with the latest news - click here

Leave a Reply