Answer-first summary for fast verification
Answer: A variance estimated from the EWMA model is a weighted average of the prior day's estimated variance and the prior day's squared return.
The correct answer is D. A variance estimated from the EWMA model is a weighted average of the prior day's estimated variance and the prior day's squared return. This is because the EWMA (Exponentially Weighted Moving Average) model is designed to give more weight to recent observations, which is suitable for modeling time-varying volatility. In contrast, the GARCH (1,1) model includes a long-run average variance component and assigns weights to both the prior day's estimated variance and the prior day's squared return, as well as the long-run average variance. Option A is incorrect because the EWMA model is a special case of the GARCH (1,1) model where the weight for the long-run variance is zero, but it is not characterized by having the long-run volatility as zero. Option B is incorrect because it omits the weight assigned to the long-run average variance rate in the GARCH (1,1) model. Option C is incorrect because the comparison of weights between the GARCH (1,1) and EWMA models can only be made under specific parameter settings and cannot be generalized.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
A novice risk analyst is in the process of creating a model to quantify the volatility of a specific market variable. The analyst is considering two different modeling approaches: the Exponentially Weighted Moving Average (EWMA) and the Generalized Autoregressive Conditional Heteroskedasticity model (GARCH(1,1)). Which one of the following statements is correct regarding these models?
A
The EWMA model is a special case of the GARCH (1,1) model with the additional assumption that the long-run volatility is zero.
B
A variance estimated from the GARCH (1,1) model is a weighted average of the prior day's estimated variance and the prior day's squared return.
C
The GARCH (1,1) model assigns a higher weight to the prior day's estimated variance than the EWMA model.
D
A variance estimated from the EWMA model is a weighted average of the prior day's estimated variance and the prior day's squared return.
No comments yet.