FIN-01-028

What Good is a Volatility Model?

January 29, 2001

Robert F. Engle and Andrew 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 stylised 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 stylised facts, and the ability of GARCH-type models to capture these features. We conclude with some challenges for future research in this area.

Classification: C22

Robert F. Engle
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Telephone: (212) 998-0710
Fax: (212) 995-4220
Email: rengle@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~rengle

Andrew J. Patton
Institution: Department of Economics, University of California, San Diego, 9500 Gilman Drive, La Jolla, CA 92093-0508

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