Explanation:
The GARCH(1,1) estimate of volatility will be:
$0.000005 + (0.13)(0.03)^2 + (0.85)(0.022)^2 = 0.000533$
(Book 4, Module 49.3, LO 49.e)
Question 45
An option trader is attempting to judge whether an option's premium is cheap or expensive. To do so, he employs a GARCH(1,1) model to forecast volatility. The particular model he estimates has an intercept term equal to 0.000005, a weighting on the latest estimate of variance of 0.85, and a weighting on the previous period's return of 0.13. If the latest volatility estimate from the model were 2.2% per day and the option's underlying asset changed 3%, the trader's estimate of the next period's standard deviation is closest to:
A
0.07%.
B
2.31%.
C
5.20%.
D
2.62%.
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