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Name of Author:
Prof. Ajay S. Ghangare
Designation:
Assistant Professor – DMT.
Institution:
Shri Ramdeobaba College of Engineering and Management,
Ramdeobaba Tekdi, Gittikhadan, Katol Road, Nagpur – 440013
Email:
ghangareas@rknec.edu , ajayghangare@gmail.com
Contact Details:
Contact : 8879569724.
Personal Address : Plot No. 24, ZingaBai Takli,New Laxmi Nagar,Pathare
Layout,Godhani Road,Opp Mahajan Complex, Nagpur 440030.
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International Journal of Pure and Applied Mathematics Special Issue
1.1 Introduction
Volatility plays a crucial role in making appropriate financial decisions. Investors, policy
formulators, researchers should be thorough with the concepts of volatility for numerous
reasons. The first being investors can assess the risk exposures in their investments. High
volatility in stock market gives alarming signals to policy makers as the instability in stocks
leads to uncertainty and thus hampers growth prospects. Investors are also unwilling to
invest in high volatile market. Finally stock return forecasting is nothing but volatility
forecasting and this in turn is beneficial for the professionals who are expert in forecasting
volatility as it facilitates job opportunities for them.(Onyeaso and Rogers, 2004).
Volatility assists in evaluating the size of errors incurred in modelling financial yields and
other relevant variables. It is a constitutive part in derivative valuation to risk and asset
management. For instance, exchange rates volatility helps in pricing currency options which
is taken for risk management. Hence, it is required to have good volatility forecasts(cited by
Franc Klassen, Improving GARCH volatility forecasts with regime switching GARCH).
From an investor’s eye it is important to have accurate forecasting of volatility in financial
market because it leads to better financial risk management and monetary policy
formulation.(Poon & Granger (2003)).
As before investing into any company, its stock prices volatility fluctuations have to be
checked and it is required to have better forecasting model.To capture volatility
forecasting,(ARCH) i.e Autoregressive conditional heteroskedasticity , (GARCH) i.e
Generalized autoregressive conditional heteroskedasticity models and stochastic volatility
models have been taken as the main tools in practice. ARCH family models are in use for
modelling and estimating the stylized aspects of the volatility behavior as noted in financial
time series inclusive of the time varying volatility or volatility clustering(Zivot and Wang,
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International Journal of Pure and Applied Mathematics Special Issue
2006).ARCH model was first introduced by Engle in 1982which was later extended to
generalised ARCH i.e GARCH by Bollerslev in 1986.Such models usually improve the fit a
lot compared with a constant variance model and, as Andersen as well as Bollerslev (1998)
claim, GARCH models comparatively give better volatility forecasts. Modelling volatility
will provide us with better insight about the stock price usefulness and more precise models
for pricing financial assets.which will ultimately assist managers, investors, as well as policy
formulators to undertake financial decisions such as raising capital, and some investment
decisions in financial markets (Emenike, 2010).
Auto Regressive Conditional Heteroscedasticity process (ARCH), which is expected to
capture mainly the dynamic behavior of conditional variance using lagged disturbance. In the
same way, study by Bollerselev (1986) suggested one step forward to overcome the problem
related to the ARCH model regarding the number of parameters, by applying Generalized
Auto Regressive Conditional Heteroscedasticity (GARCH) model. In this way Instead of
having infinite parameters using ARCH models, we can reduce the number into only two
parameters in GARCH model. Accordingly, both ARCH and GARCH models that were
proposed by Engle (1982) and Bollerslev (1986) respectively, can capture simultaneously
volatility clustering and leptokurtosis. So in return they have been widely employed in
financial markets analysis studies. But on the other hand, they both fail to capture the
leverage effect. Hence, Nelson (1991) proposed one of the extended ARCH models by using
Exponential Generalized Auto Regressive Conditional Heteroscedasticity well known as
(EGARCH) model, in order to track the asymmetric shocks of the conditional variance
(Gokcan, 2000; Su, 2010; Abd AL Aal, 2011; Ezzat, 2012; Freedi et. al, 2012).
Although comparative analysis of volatility models of many countries stock markets has been
extensively studied by many researchers, studies related to any particular financial
institution’s stock prices have been few and need to focus on. That inspired this paper to
research in that direction. State bank of India being the largest public sector bank of India can
give to investor a better insight about understanding of volatility in the share prices of SBI.
Better understanding of the volatility can give better prospects to an investor to invest in any
particular company.
The remaining of this paper is organized as follows: section 1.2 shows related literature
review, section 1.3 gives by research methodology followed by section 1.3.1 with objectives
of the study ,1.4 with analysis and findings and section 1.5 with conclusion and section 1.6
gives references .
1.2 Literature Review
Understanding volatility of a stock is vital from an investor’s point of view. As it facilitates
with better insights about a particular stock or a sector or a market which is essential in taking
good financial decisions the factor responsible for stock’s volatility has been an unsettled
question in finance sector. While many researchers had attempted to forecast the volatility
using different theories or traditional models, Engle (1982) being the pioneer in introducing
ARCH model and Bollerslev (1999) who proposed the GARCH model(extended ARCH) did
influence others with their financial models for further research. We have studied the
literature in this regards to have a better evidence for our study. Some of the glimpses of most
prominent studies have been revealed below.
Dana Alnajjar (2016) attempted to forecast the volatility of Jordan’s capital market using
GARCH family models. The study comprises of three models i.e ARCH,GARCH and
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International Journal of Pure and Applied Mathematics Special Issue
EGARCH to find out volatility clustering, leptokurtosis and leverage effect on Amman stock
exchange which showed that ARCH GARCH gives more evidence for both volatility
clustering and leptokurtic.
Hojin Lee (2009) investigated the superiority of GARCH models and symmetric effect in
stock market volatility using GARCH Models on stock market historical prices where the
results were unmatched with the previous theory which claimed that there are asymmetric
effects in the stock market volatility.
Hojatallah Goudarzi, C. S. Ramanarayanan (2010)using ARCH and GARCH models did
find out the volatility of the Indian stock market index BSE500 where GARCH(1,1) model
werecome out to be the bestfitted model after analysing criterion such as ARCH-LM test and
LB Statistics, SIC and AIC.
Kumar(2006)has done the comparative analysis of different forecasting models using Indian
stock exchange data .whereas Karunanithy Banumathy and Ramachandran Azhagaiah
have jointly investigated about the Modelling of Stock Market Volatility using Indian stock
exchange data. The analysis has applied GARCH Family Models on historical data and
compared Akaike Information Criterion (AIC) and Schwarz Information Criterion (SIC)
criterions.
Numerous studies have been carried out to analyse the performance of ARCH GARCH
Family models on different stock exchanges datacomprising studies by (French 1987,
Schwert and Stambaugh 1987; Chou 1988; Kenneth 2013 ). Karmakar(2005) did study
on volatility of Indian stock market index where he showed the presence of leverage effect
and the suitability of GARCH (1,1) model gaveremarkably good forecasts of market
volatility.
Zakaria and Winker(2012) investigated conditional variance using GARCH-M model in
Khartoum Stock Exchange (kse) and Cairo and Alexandria Stock Exchange(case).Mittal,
Arora, and Goyal (2012) observed the asymmetric behaviour in volatility of Indian stock
prices when studied on the daily returns for 10 years data from 2000 to 2010 which ultimately
concluded that the GARCH and P GARCH models were come out as the best suited models
to show symmetric and asymmetric effect respectively. Vijayalakshmi and Gaur (2013)
studied eight different models to forecast volatility in Indian and foreign stock markets
indices.
Dima Alberga (2008) used Tel Aviv Stock Exchange (TASE) market’s data to calculate
volatility using asymmetric GARCH models and observed that the asymmetric GARCH
model with fat-tailed densities enhanced overall estimation for measuring conditional
variance.
Since ARCH and GARCH are not able toshow the leverage effect, Nelson (1991) proposed
nonlinear extensions of GARCH, that is Exponential GARCH (EGARCH) model, and also
Glosten et al. (1993) proposed GJR model came up with the Asymmetric Power ARCH
(APARCH) model .Harris et al. (2004) incorporated the skewed generalized Student’s t-
distribution to capture the skewness and leverage effects of daily returns in order to enhance
the fit of the GARCH and EGARCH models into international equity markets. Pagan and
Schwert (1990), Brailsford and Faff (1996) and Loudon et al. (2000) have shown
evidences of conditional variance with asymmetric GARCH models.
A comparative study of normal density with non normal ones was carried out by Baillie and
Bollerslev (1989), McMillan, et al. (2000), Lambert and Laurent (2001) calculated the
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International Journal of Pure and Applied Mathematics Special Issue
Stock Market Volatility based on Non-linear Models and they also concentrated on
developing the GARCH model for daily closing price of S&P 500 stock price.
Arowolo W B (1) after studying the daily stock prices of Zenith bank PLC in Nigeria stock
exchange came to conclusion that GARCH (1,2) was the best suited model to forecast
volatility.
WEI Jianguo , Md. Qamruzzaman estimated the Stock Market Volatility using
Asymmetric ARCH, GARCH and Expanded GARCH Models found out that GARCH model
which have leverage effect does improve the model performance.
GARCH(1,1) has come out to be the best fitted model in a study by Hansen & Lunde
(2005). Similar studies by Wilhelmsson (2006) have demonstrated that the use of fat tailed
error distributions within a GARCH(1,1) framework leads to improved volatility forecasts.
Several studies have been done on measuring stock markets volatility across different parts of
the world. But very few of them have been done on one company. That motivated this work
to attempt to apply these forecasting modules on one company’s historical stock prices and
find out what effect these models have on volatility and which is the best suited model to
forecast volatility.
1.3 Research Methodology:
The main motive of this research paper is to find out the suitable ARCH Family model to
estimate the Market volatility of SBI Share prices for last 10 years from 26th August 2007 to
13th August 2017.
First of all, there is a need to check whether the data is stationary or not. If it is not stationary
then we have to make the data stationary. We have assumed that our data is stationary and
then carried out all the tests pertaining as per the requirement of analysis. To start with we
have first run the regression line equation. Numerous statistical tools including ARCH LM
Tests, residuals , ARCH and GARCH H Family models comprises of
ARCH,GARCH,EGARCH & TARCH models , Heteroscedasticity tests were applied and
analysed using E-views 9SV package. Suitable Volatility model has been suggested after
analysis of all these tests. It is imperative to check the residuals of the sample for the
evidence of heteroscedasticity.
Heteroscedasticity test –ARCH test using least square method where the values of obs* R-
squared & probability chi square (1) were observed as less than 5%. We set up a null
hypothesis for the test which can be seen in data analysis section. Since the null hypothesis is
rejected, we could run the ARCH Family models. We commenced with ARCH 5, GARCH 0
model using ML ARCH normal distribution method. From mean equation, residual for the
sample is checked and processed to estimate the variance equation. ARCH model consists of
two parts mean equation and variance equation. We later on applied GARCH ,
EGARCH,TARCH Models to the same sample using normal distribution method. Best suited
model was identified by comparing the AIC and SIC values. Finally the conditions of serial
correlations , ARCH effect and normal distribution were checked to estimate the best fitted
model.
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International Journal of Pure and Applied Mathematics Special Issue
• To investigate the volatility pattern of State Bank of India with the help of its National
Stock Exchange data using symmetric and asymmetric models. Evidence from India
•To analyse and select the BEST fitted model of ARCH and Generalized Autoregressive
Conditional Heteroscedastic (GARCH) family models that shows the essential facts about the
index returns.
1.3.2 Data Source:
This study has taken secondary data collected from Yahoo Finance data base. State Bank of
India’s share prices were taken into consideration. The weekly closing prices of SBI Stock
prices over the period of Ten years from 26 August 2007 to 13 August 2017 were collected
and used for the data analysis.
1.4 Analysis and Findings
We start by assuming that our variable logclose is stationary. If it is not stationary then we
need to make it stationary first. Only then we can estimate ARCH and Garch H Model. Log
close C first run the regression line. Result is as shown below:
Dependent Variable: LOGCLOSE
Method: Leas t Squares
Date: 12/22/17 Tim e: 12:04
Sam ple: 8/26/2007 8/13/2017
Included obs ervations : 516
We have to check the residual of the above model. And it comes as below:
6.0
5.6
0.8
0.4 5.2
0.0
4.8
-0.4
4.4
-0.8
-1.2
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Running of ARCH Family models is carried out. Lets first carried out ARCH Test for
whether to run ARCH Family models or not. ARCH Test
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International Journal of Pure and Applied Mathematics Special Issue
Tes t Equation:
Dependent Variable: RESID^2
Method: Leas t Squares
Date: 12/22/17 Tim e: 13:09
Sam ple (adjus ted): 9/02/2007 8/13/2017
Included obs ervations : 514 after adjus tm ents
From the above table, we got two values Obs*R-squared value as 456.3420 and Prob. Chi-
Square (1) as 0.0000 which is less than 5% meaning that we can reject null hypothesis and we
can accept alternative hypothesis. It also mean that our model has ARCH Effect.
Null Hypothesis: There is no ARCH Effect in the data sample of State Bank of India.
Alternative Hypothesis: There is an ARCH Effect in the data sample of State Bank of
India.
So we can run the ARCH Family models such as GARCH, EGARCH, TARCH and so on.
Lets start with the ARCH 5, GARCH 0 model using Normal Distribution.
Dependent Variable: LOGCLOSE
Method: ML ARCH - Norm al dis tribution (BFGS / Marquardt s teps )
Date: 12/22/17 Tim e: 13:38
Sam ple: 8/26/2007 8/13/2017
Included obs ervations : 516
Failure to im prove likelihood (non-zero gradients ) after 68 iterations
Coefficient covariance com puted us ing outer product of gradients
Pres am ple variance: backcas t (param eter = 0.7)
GARCH = C(2) + C(3)*RESID(-1)^2 + C(4)*RESID(-2)^2 + C(5)*RESID(-3)^2
+ C(6)*RESID(-4)^2 + C(7)*RESID(-5)^2
Variance Equation
From the above table we have got the mean equation. From the mean equation, we have
extracted residual and used residual to estimate variance equation. It means that ARCH
model has two parts. They are mean equation and the variance equation. From the above
table the value of Akaike Info Criteron (AIC) comes out to be -0.921001 and the Schwarz
Criterion (SC) is -0.863399.
Our guideline for finding out the best suited model is that lower the values of AIC, SC, better
the model. Our objective is to find out the best model having lowest AIC and SC values.
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International Journal of Pure and Applied Mathematics Special Issue
Now applying (GARCH (1,1)) model to our sample. Outcome of the test is as followed:
Dependent Variable: LOGCLOSE
Method: ML ARCH - Norm al dis tribution (BFGS / Marquardt s teps )
Date: 12/22/17 Tim e: 14:23
Sam ple: 8/26/2007 8/13/2017
Included obs ervations : 516
Failure to im prove likelihood (non-zero gradients ) after 25 iterations
Coefficient covariance com puted us ing outer product of gradients
Pres am ple variance: backcas t (param eter = 0.7)
GARCH = C(2) + C(3)*RESID(-1)^2 + C(4)*GARCH(-1)
Variance Equation
From the above table values of AIC is observed as -0.922433 and SIC is -0.889517, now
applying TARCH Model which is also known as GJR- GARCH Model. Observed values of
table are followed:
Dependent Variable: LOGCLOSE
Method: ML ARCH - Norm al dis tribution (BFGS / Marquardt s teps )
Date: 12/22/17 Tim e: 14:32
Sam ple: 8/26/2007 8/13/2017
Included obs ervations : 516
Failure to im prove likelihood (non-zero gradients ) after 35 iterations
Coefficient covariance com puted us ing outer product of gradients
Pres am ple variance: backcas t (param eter = 0.7)
GARCH = C(2) + C(3)*RESID(-1)^2 + C(4)*RESID(-1)^2*(RESID(-1)<0) +
C(5)*GARCH(-1)
Variance Equation
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International Journal of Pure and Applied Mathematics Special Issue
Variance Equation
From the above table, observed value of AIC is -0.868056 and SC Value is -0.826911.
So far we have estimated four models from ARCH Family and the objective of this paper to
find out the best suited model.
We have made the table comparing the values of AIC and SIC.
Sr. Model Akaike Info Criterion (AIC) Schwarz Criterion (SIC)
No.
1 ARCH -0.921001 -0.863399
2 GARCH -0.922433 -0.889517
3 TARCH -0.917775 -0.876631
4 EGARCH -0.868056 -0.826911
After comparing the above four models, GARCH model comes out to be the best suited
model as per analysis as the values of AIC and SC are the smallest in case of GARCH Model.
Let’s now do the diagnostic checking of the GARCH model. For this, we have again
estimated the GARCH Model. We have to check whether the model has serial correlation or
not. For checking the Serial Correlation we have to perform Correlogram Squared Residual
Test. And the result is as followed.
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Test Equation:
Dependent Variable: WGT_RESID^2
Method: Least Squares
Date: 12/22/17 Tim e: 16:39
Sam ple (adjusted): 9/02/2007 8/13/2017
Included observations: 515 after adjustm ents
From the above table, it is observed that the value of obs*R-squared is 0.007789 and the
value of Prob. Chi-Square is 0.9297. Since the value of Prob. Chi- Square is 92.97% which is
more than 5%. Hence we cannot reject our Null Hypothesis meaning we have to accept the
hypothesis. So all conditions have been satisfied.
Now we have to check about the normal distribution of the residuals. To check the normal
distribution of the residuals we have to perform the histogram test. The outcome of this test is
as followed. Assuming Null Hypothesis as
Null Hypothesis : Residuals are normally distributed in the series of State Bank of India.
Alternative Hypothesis : Residuals are not normally distributed in the series of State Bank of
India.
100
Series: Standardized Residuals
Sample 8/26/2007 8/13/2017
80
Observations 516
60 Mean -0.080823
Median -0.289915
Maximum 2.470856
40
Minimum -2.913520
Std. Dev. 1.041605
20 Skewness 0.084572
Kurtosis 1.733641
0
Jarque-Bera 35.09390
-3 -2 -1 0 1 2
Probability 0.000000
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International Journal of Pure and Applied Mathematics Special Issue
Null Hypothesis : Residuals are normally distributed in the data sample of State Bank of
India.
Alternate Hypothesis : Residuals are not normally distributed in the data sample of State
Bank of India.
Since our probability value comes out to be 0.000 meaning that we can reject the null
hypothesis. Means we accept the Alternative hypothesis. Which is not desirable .So the
condition of checking the normal distribution of the model is not satisfied. But since this
model has no serial correlation and does not have ARCH Effect. Many economists say that
we can accept the model even though the residuals are not normally distributed we can accept
the model. This model satisfies two criterions i.e. it no serial correlation and it does not have
ARCH effect.
The following findings have been reported after the empirical analysis of the study :
The sum of the coefficients of (α + β) in all the models applied are as followed :
Sr. Model (α + β)
No.
1 ARCH 0.991495
2 GARCH 0.976473
3 TARCH 1.033684
In GARCH (1,1) model, the sum of the coefficient (α + β) is 0.976473, which concludes that
the volatility has come out to be highly persistent.
In EGARCH Model the value of C(4) has come out to be negative indicates that it increases
the volatility.
• The coefficient of conditional variance or risk premium (λ) in the mean equation of
GARCH (1,1) model has observed as 5.411580 which is positive and insignificant, which
shows that higher market risk provided by conditional variance will not necessarily lead to
higher returns.
The best suited model is selected using the lowest values of AIC and SIC criterions. Both the
values are lowest for GARCH (1,1) model when compared to the other applied models
including ARCH,TARCH and EGARCH.
The GARCH (1, 1) Model has AIC and SIC values as (-0.922433,-0.889517) passed the
desired norms and hence it is apparently seems to be a proper description of asymmetric
volatility process.
1.5. Conclusion
Best model for estimating volatility of State Bank of India’s share prices is investigated by
applying four ARCH Family models i.e. ARCH(5,0),GARCH(1,1),TARCH(1,1) and
EGARCH(1,1)using weekly data collected from National Stock Exchange. The final outcome
has been arrived on after successfully investigating the stationary of the series followed by
checking the effect of ARCH in the series and ultimately applying the ARCH Family models
and checking the serial correlations of the best fitted model. GARCH model has
outperformed all other models based on two criterions i.e Akaike Information Criterion (AIC)
and Schwarz Information Criterion (SIC) and all the applied statistics reports. Overall Study
concludes that GARCH model best describes the volatility of share prices of State Bank of
India.
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