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Volatility clustering
is a property of most
heteroskedastic
stochastic
processes used in finance and economics. Heteroskedasticity, recall,
is the property of time-varying (conditional or unconditional)
variance in a stochastic
process. Volatility clustering is the property that there are periods of
high and low (conditional or unconditional) variance. The
volatility "clusters." This is
illustrated in Exhibit 1. Its top graph is a realization of a
heteroskedastic stochastic process without volatility clustering. Its
volatility fluctuates, but it is independent from one time to the next.
The second graph is a heterokedastic stochastic process with volatility
clustering.
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Two time series are illustrated. The first
does not exhibit volatility clustering. The second one does. |
Financial markets exhibit volatility clustering. They have
periods of elevated volatility interspersed among more tranquil periods.
Various stochastic processes are used to model volatility clustering,
including ARCH,
GARCH and
stochastic
volatility models.
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