PRACTICAL 3: Studying the volatility with SPSS

1. Moving average method for volatility in log returns a. First you can use moving average method simply to predict the next time log returns. When is this good and when is it not so? b. Assume that your log returns have mean zero. Compute the squared log returns Y(t)2 and plot the series. c. Moving average of suitable span will give you a volatility estimate timewise. Compute a 5-day moving average estimate of the squared residuals (Transform/Create time series/prior moving average using span=5). d. Compute also a 20-day and 60-day moving average of the squared residuals. e. What do these moving averages estimate? f. Compute the square root of the three moving average estimates you have obtained, and plot them on the same graph using (Analyze/forecasting/sequence chart.). Comment the differences you observe between the three estimators of the volatility: Does the volatility look constant over time? How do the three volatility estimators differ? g. Which of the three volatility estimators would you use to predict tomorrow and why? Give a prediction for the volatility of the day after the last observed return. h. Suppose you want to have the volatility estimate for hth day from today. Obtain this estimate. What assumptions are you making here i. Finally if your log returns do have mean zero what adjustments that you may need in calculating volatility estimates?

2. Exponentially weighted moving average (EWMA) a. Compute the EWMA estimate of the volatility. Note that SPSS make an optimal choose of the smoothing parameter . (Analyze/forecasting/create model pick exponential smoothing) Make sure to save the fitted values. b. Take the square root of the EWMA fitted values to obtain standard deviations as volatility measures (as we did in 1. above). c. Plot the volatility estimate obtained in b. Write the estimated value of and the interpretation of (that was given in the lectures) to comment the graph. d. Obtain the volatility estimate for hth day from the last day of the time series. e. Discuss the advantages of EWMA method over the simple MA method (if needed pretend that you can select as you wish)

3. AR/ARCH modeling (you may sue the example data given or data series of your choice) a. Fit an AR model to the data first. Check the residuals (make sure to get them in a column). Are they autocorrelated? Check for any heteroscedasticity in them. b. If you see that the residuals are homoscedastic do you need to go further in modeling them? c. When do you need to model the residuals possibly with an ARCH model? d. As discussed in the lecture why zero autocorrelation does not imply that the residuals are independent? e. To see the nonindependence (nonconstant conditional variance) of residuals obtain the squared residuals and look at their partial autocorrelations (Analyze/forecasting/Autocorrelations) f. If squared residuals are autocorrelaed, model them with another AR model (Analyze/forecasting/Createmodel pick Arima critera: p=what you got.) Make sure you save the fits. This model will be your ARCH model. g. Write down your AR/ARCH model for your data h. Plot on the same graph three volatility estimates: one form moving average and another from EWMA and the other from ARCH estimate obtained above. Comment briefly the differences. (Analyze/forecasting/sequence chart.) i. Give a prediction for the volatility for the next day of the day where observed data end. j. Use this prediction of the volatility to construct a 95% prediction interval for tomorrows return.