Explanation:
The GARCH(1,1) estimate of volatility (standard deviation) will be:
variance = 0.000008 + (0.16)(0.034)² + (0.78)(0.026)²
variance = 0.000008 + 0.00018496 + 0.00052728
variance = 0.00072024
volatility (standard deviation) = √variance
volatility = √0.00072024 = 2.68%
(Book 4, Module 49.3, LO 49.e)
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Question 65
An options trader is attempting to judge whether an option's premium is cheap or expensive using a GARCH(1,1) model to forecast volatility. The intercept of the model has a value of 0.000008, the weighting on the latest estimate of variance is 0.78, and the weighting on the previous period's return is 0.16. If the latest volatility estimate from the model was 2.6% per day and the option's underlying asset value changed by 3.4%, the trader's estimate of the next period's standard deviation is closest to:
A
0.03%.
B
0.07%.
C
2.68%.
D
3.38%.
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