**Freakonometrics » R-english**, and kindly contributed to R-bloggers)

Consider some ARCH() process, say ARCH(),

where

with a Gaussian (strong) white noise .

> n=500 > a1=0.8 > a2=0.0 > w= 0.2 > set.seed(1) > eta=rnorm(n) > epsilon=rnorm(n) > sigma2=rep(w,n) > for(t in 3:n){ + sigma2[t]=w+a1*epsilon[t-1]^2+a2*epsilon[t-2]^2 + epsilon[t]=eta[t]*sqrt(sigma2[t]) + } > par(mfrow=c(1,1)) > plot(epsilon,type="l",ylim=c(min(epsilon)-.5,max(epsilon))) > lines(min(epsilon)-1+sqrt(sigma2),col="red")

(the red line is the conditional variance process).

> par(mfrow=c(1,2)) > acf(epsilon,lag=50,lwd=2) > acf(epsilon^2,lag=50,lwd=2)

We did mention in class that if a ARCH(), then is an AR() process. So a first idea is to consider a regression, as we did for Gaussian AR()

> db=data.frame(Y=epsilon[2:n]^2,X1=epsilon[1:(n-1)]^2) > summary(lm(Y~X1,data=db)) Call: lm(formula = Y ~ X1, data = db) Residuals: Min 1Q Median 3Q Max -2.4538 -0.3618 -0.2626 0.0935 9.3667 Coefficients: Estimate Std. Error t value Pr(>|t|) (Intercept) 0.34963 0.04342 8.052 6.08e-15 *** X1 0.31123 0.04262 7.303 1.13e-12 *** --- Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1 Residual standard error: 0.8413 on 497 degrees of freedom Multiple R-squared: 0.0969, Adjusted R-squared: 0.09508 F-statistic: 53.33 on 1 and 497 DF, p-value: 1.129e-12

There is some significant autocorrelation here. But since our vectors cannot be considered as Gaussian, using least squares is perhaps not the best strategy. Actually, if our series is not Gaussian, it is still conditionally Gaussian, since we assumed that is a Gaussian (strong) white noise,

The likelihood is then

and the log-likelihood is

And a natural idea is to define

The code is simply

> X=epsilon > loglik=function(param){ + w=exp(param[1]) + a1=exp(param[2]) + s2=rep(w,n) + for(t in 2:length(X)){s2[t]=w+a1*X[t-1]^2} + logL=-.5*sum(log(s2))-.5*sum(X^2/s2) + return(-logL) + } > OPT=optim(par= + coefficients(lm(Y~X1,data=db)),fn=loglik) > exp(OPT$par) (Intercept) X1 0.2482241 0.5858578

(since the parameters have to be positive, we assume here that they can be written as the exponential of some real values). Observe that those values are closer to the one used to generate our time series.

If we use R functions to estimate those parameters, we get

> library(tseries) > summary(garch(epsilon,c(0,1))) ... Call: garch(x = epsilon, order = c(0, 1)) Model: GARCH(0,1) Residuals: Min 1Q Median 3Q Max -2.87023 -0.60836 -0.03426 0.66648 3.48443 Coefficient(s): Estimate Std. Error t value Pr(>|t|) a0 0.24959 0.02470 10.104 < 2e-16 *** a1 0.58306 0.09737 5.988 2.13e-09 *** --- Signif. codes: 0 '***' 0.001 '**' 0.01 '*' 0.05 '.' 0.1 ' ' 1

so that the confidence interval for is

> summary(garch(epsilon,c(0,1)))$coef[2,1]+ + c(-1.96,1.96)*summary(garch(epsilon,c(0,1)))$coef[2,2] [1] 0.3922088 0.7739088

Actually, since our main interest is this parameter, it is possible to use profile likelihood techniques,

> proflik=function(a){ + loglik=function(w){ + s2=rep(w,n) + for(t in 2:length(X)){s2[t]=w+a*X[t-1]^2} + logL=-.5*sum(log(s2))-.5*sum(X^2/s2) + return(-logL)} + return(-optim(par=.3,fn=loglik)$value)} > A=seq(0,2,by=.05) > P=Vectorize(proflik)(A) > par(mfrow=c(1,1)) > plot(A,P,type="l") > OPT=optimize(function(x) -proflik(x), interval=c(0,2)) > t=-OPT$objective-qchisq(.95,df=1) > abline(h=t,col="red") > ainf=uniroot(function(x) proflik(x)-t,c(0,OPT$minimum))$root > asup=uniroot(function(x) proflik(x)-t,c(OPT$minimum,2))$root > abline(v=ainf,lty=2) > abline(v=asup,lty=2)

Of course, all those techniques can be extended to higher order ARCH processes. For instance, if we assume that we have a ARCH() time series

where now

with a Gaussian (strong) white noise . The log-likelihood is still

and we can define

The code above can be changed, to take into account this additional component,

> db=data.frame(Y=epsilon[3:n]^2, + X1=epsilon[2:(n-1)]^2, + X2=epsilon[1:(n-2)]^2) > X=epsilon > loglik=function(param){ + w=exp(param[1]) + a1=exp(param[2]) + a2=exp(param[3]) + s2=rep(w,n) + for(t in 3:length(X)){s2[t]=w+a1*X[t-1]^2+a2*X[t-2]^2} + logL=-.5*sum(log(s2))-.5*sum(X^2/s2) + return(-logL) + } > OPT=optim(par= + coefficients(lm(Y~X1+X2,data=db)),fn=loglik) > exp(OPT$par) (Intercept) X1 X2 0.22710526 0.59475474 0.04741294

We can also consider some Generalized ARCH process, e.g. a GARCH(,),

where now

Again, maximum likelihood techniques can be used. Actually, we can also code Fisher-Scoring algorithm, since (in a very general context)

with here . Using a standard gradient descent algorithm, we get the following estimate for our GARCH process,

> X=epsilon > theta=c(.2,.2,.2) > G=rep(1,3) > n=length(X) > j=1 > while(sum(G^2)>1e-12){ + s2=rep(theta[1],n) + for (i in 2:n){s2[i]=theta[1]+theta[2]*X[(i-1)]^2+theta[3]*s2[(i-1)]} + z=(X^2-s2)/s2^2 + V=cbind(z[2:n],z[2:n]*X[1:(n-1)]^2,z[2:n]*s2[1:(n-1)]) + H=(t(V)%*%V) + G=apply(V,2,sum) + theta=theta+solve(H)%*%G + j=j+1} > as.numeric(theta) [1] 0.20372918 0.59183911 0.08936159

The interesting point, here, is that we also derive the (asymptotic) variance

> (stdev=sqrt(diag(solve(H)))) [1] 0.01849067 0.04950477 0.02937233

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