Econometrica: Jan 1993, Volume 61, Issue 1

Common Persistence in Conditional Variances

https://doi.org/0012-9682(199301)61:1<167:CPICV>2.0.CO;2-7
p. 167-186

Robert F. Engle, Tim Bollerslev

Since the introduction of the autoregressive conditional heteroskedastic (ARCH) model in Engle (1982), numerous applications of this modeling strategy have already appeared. A common finding in many of these studies with high frequency financial or monetary data concerns the presence of an approximate unit root in the autoregressive polynomial in the univariate time series representation for the conditional second order moments of the process, as in the so-called integrated generalized ARCH (IGARCH) class of models proposed in Engle and Bollerslev (1986). In the IGARCH models shocks to the conditional variance are persistent, in the sense that they remain important for forecasts of all horizons. This idea is readily extended to a multivariate framework. Even though many time series may exhibit persistence in variance, it is likely that several different variables share the same common long-run component. In that situation, the variables are naturally defined to be co-persistent in variance, and the co-persistent linear combination is interpretable as a long-run relationship. Conditions for co-persistence to occur in the multivariate linear GARCH model are presented. These conditions parallel the conditions for linear co-integration in the mean, as developed by Engle and Granger (1987). The presence of co-persistence has important implications for asset pricing relationships and in optimal portfolio allocation decisions. An empirical example relating to the time series properties of nominal U.S. dollar exchange rates for the deutschemark and the British pound provides a simple illustration of the ideas.

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