Explanation:
The GARCH (1,1) estimate of volatility will be as follows:
Variance = 0.000008 + (0.16)(0.034)² + (0.78)(0.026)²
Variance = 0.000008 + 0.00018496 + 0.00052728
Variance = 0.00072024
Volatility = √variance
Volatility = √0.00072024 = 2.68%
(Book 4, Module 49.3, LO 49.e)
Ultimate access to all questions.
Question 43
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 previous variance and return are 0.78 and 0.16, respectively. If the latest volatility estimate from the model was 2.6% per day, and the option's underlying asset 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%.
No comments yet.