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Booth School of Business, University of Chicago
Business41202,SpringQuarter2012,Mr. RueyS.Tsay
Solutions to Midterm
ProblemA:(34pts)Answerbrie?ythefollowingquestions. Eachquestion
hastwopoints.
1. Describe twoimprovementsoftheEGARCHmodel overtheGARCH
volatilitymodel.
Answer: (1)allowsforasymmetricresponsetopastpositiveornegative
returns, i.e. leverage e?ect, (2) uses log volatility to relax parameter
constraint.
2. DescribetwomethodsthatcanbeusedtoinfertheexistenceofARCH
e?ectsinareturnseries,i.e.,volatilityisnotconstantovertime.
Answer: (1) The sample ACF (or PACF) of the squared residuals of
the mean equation, (2) use the Ljung-Box statistics on the squared
residuals.
3. Consider the IGARCH(1,1) volatility model: at = σtt with σ
2
=
t
. Often one pre-?xes α0 = 0. Why? Also,
suppose that α =0 and the 1-step ahead volatility prediction at the
α0+β1σ
2
+(1?β1)a
2
t?1
t?1
0
forecastoriginhis16.2%(annualized),i.e.,σh(1)=σh+1=16.2forthe
percentagelogreturn. Whatisthe10-stepaheadvolatilityprediction?
Thatis,whatisσh(10)?
Answer: (1)Fixingα0=0basedonthepriorknowledgethatvolatility
ismeanreverting. (2)σh(10)=16.2.
4. (Questions 4 to 8) Consider the daily log returns of Amazon stock
from January 3, 2007 to April 27, 2012. Some summary statistics of
thereturnsaregivenintheattachedRoutput. Istheexpected(mean)
returnofthestockzero? Why?
Answer: Thedatadoesnotprovidesu?cientevidencetosuggestthat
themeanreturnisnotzero,because the95%con?denceintervalcon-
tainszero.
5. Letk betheexcesskurtosis. TestH0:k=0versusHa:k=0. Write
downtheteststatisticanddrawtheconclusion.
1
Answer: t-ratio = √9.875 = 73.79, which is highly signi?cant com-
24/1340
2
paredwithχ1 distribution.
6. Arethereserialcorrelationsinthelogreturns? Why?
Answer: No,theLjung-BoxstatisticQ(10)=10.69withp-value0.38.
7. ArethereARCHe?ectsinthelogreturnseries? Why?
Answer: Yes,theLjung-BoxstatistofsquaredresidualsgivesQ(10)=
39.24withp-valuelessthan0.05.
8. Based on the summary statist
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