Question: 3. (a) Distinguish between the terms conditional variance and unconditional variance. Which of the two is more likely to be relevant for producing: i. one-step-ahead

(a) Distinguish between the terms ‘conditional variance’ and ‘unconditional variance’. Which of the two is more likely to be relevant for producing:

i. one-step-ahead volatility forecasts ii. twenty-step-ahead volatility forecasts.

(b) If ut follows a GARCH(1,1) process, what would be the likely result if a regression of the form (9.121) were estimated using OLS and assuming a constant conditional variance?

(c) Compare and contrast the following models for volatility, noting their strengths and weaknesses:

i. Historical volatility ii. EWMA iii. GARCH(1,1)

iv. Implied volatility.

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