Volatility clustering: Difference between revisions

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In [[finance]], '''volatility clustering''' refers to the observation, first noted as [[Benoît Mandelbrot|Mandelbrot]] (1963), that "large changes tend to be followed by large changes, of either sign, and small changes tend to be followed by small changes."<ref>Mandelbrot, B. B., [[https://www.jstor.org/stable/2351623| The Variation of Certain Speculative Prices]], The Journal of Business 36, No. 4, (1963), 394-419</ref> A quantitative manifestation of this fact is that, while returns themselves are uncorrelated, absolute returns <math>|r_{t}|</math> or their squares display a positive, significant and slowly decaying autocorrelation function: corr(|r{{sub|t}}|, |r{{sub|t+τ}} |) > 0 for τ ranging from a few minutes to several weeks.<ref>Cont,{{cite Rama (2005).conference "[|url=https://doi.org/10.1007/1978-846283-048540-6_1134625-8_10 Long|title= rangeVolatility dependenceClustering in financialFinancial markets]".Markets: Empirical Facts Inand LévyAgent-VéhelBased J.,Models|last1=Cont Lutton|first1=Rama E.|date=2007 (eds)|publisher= FractalsSpringer|book-title=Long Memory in Engineering.Economics|editor2-last=Teyssiere|editor2-first=Gilles|editor1-last=Kirman|editor1-first=Alan|pages= Springer,289-309 London|doi=10.1007/978-3-540-34625-8_10 pp. 159–179.}}</ref>

Some studies point further to long-range dependence in volatility time series.

Observations of this type in financial time series have led to the use of [[GARCH]] models and mean-reverting [[stochastic volatility]] models in financial forecasting and [[Derivative (finance)|derivatives]] pricing. The [[ARCH]] ([[Robert F. Engle|Engle]], 1982) and [[GARCH]] ([[Tim Bollerslev|Bollerslev]], 1986) models aim to more accurately describe the phenomenon of volatility clustering and related effects such as [[kurtosis]]. The main idea behind these two models is that volatility is dependent upon past realizations of the asset process and related volatility process. This is a more precise formulation of the intuition that asset [[Volatility (finance)|volatility]] tends to revert to some mean rather than remaining constant or moving in [[monotonic]] fashion over time.

<ref>Cont, Rama (2005). "[https://doi.org/10.1007/1-84628-048-6_11 Long range dependence in financial markets]". In Lévy-Véhel J., Lutton E. (eds) Fractals in Engineering. Springer, London. pp. 159–179.</ref><ref>

{{cite encyclopedia |author= Ole E. Barndorff-Nielsen, Neil Shephard|title= Volatility|encyclopedia= Encyclopedia of Quantitative Finance|date= October 2010 |year= 2010 |publisher= Wiley|editor-last= Cont|editor-first=Rama |doi=10.1002/9780470061602.eqf19019 }}

</ref>

Observations of this type in financial time series go against simple random walk models and have led to the use of [[GARCH]] models and mean-reverting [[stochastic volatility]] models in financial forecasting and [[Derivative (finance)|derivatives]] pricing. The [[ARCH]] ([[Robert F. Engle|Engle]], 1982) and [[GARCH]] ([[Tim Bollerslev|Bollerslev]], 1986) models aim to more accurately describe the phenomenon of volatility clustering and related effects such as [[kurtosis]]. The main idea behind these two models is that volatility is dependent upon past realizations of the asset process and related volatility process. This is a more precise formulation of the intuition that asset [[Volatility (finance)|volatility]] tends to revert to some mean rather than remaining constant or moving in [[monotonic]] fashion over time.

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==References==

{{Reflist}}

==Additional References==

{{cite conference |url=https://doi.org/10.1007/978-3-540-34625-8_10 |title= Volatility Clustering in Financial Markets: Empirical Facts and Agent-Based Models|last1=Cont |first1=Rama |date=2007 |publisher= Springer|book-title=Long Memory in Economics|editor2-last=Teyssiere|editor2-first=Gilles|editor1-last=Kirman|editor1-first=Alan|pages= 289-309 |doi=10.1007/978-3-540-34625-8_10 }}

{{cite encyclopedia |author= Ole E. Barndorff-Nielsen, Neil Shephard|title= Volatility|encyclopedia= Encyclopedia of Quantitative Finance|date= October 2010 |year= 2010 |publisher= Wiley|editor-last= Cont|editor-first=Rama |doi=10.1002/9780470061602.eqf19019 }}

{{Volatility}}