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.
**D is correct.** The EWMA (Exponentially Weighted Moving Average) estimate of variance is indeed a weighted average of the variance rate estimated for the prior day and the prior day's observed squared return. This is the fundamental formulation of the EWMA model. **A is incorrect.** While EWMA is a special case of GARCH(1,1), it's not because the long-run volatility is zero. Rather, it's when the weight assigned to the long-run average variance rate (γ) is zero, and the sum of the weights for the prior day's variance (β) and prior day's squared return (α) equals 1. **B is incorrect.** The GARCH(1,1) model includes three components: weight on the prior day's variance (β), weight on the prior day's squared return (α), and weight on the long-run average variance rate (γ). It's not just a weighted average of the prior day's estimated variance and squared return. **C is incorrect.** The relative weight assignment between GARCH(1,1) and EWMA depends on the specific parameter values chosen, and there's no inherent rule that GARCH(1,1) always assigns higher weight to the prior day's estimated variance.
Author: LeetQuiz .
Ultimate access to all questions.
A junior risk analyst is modeling the volatility of a certain market variable. The analyst considers using either the EWMA or the GARCH (1,1) model. Which of the following statements is correct?
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.