GARCH model

Welcome back to my YouTube channel where we learn all about derivatives and quantitative finance.

In today's video, we're gonna learn about time-varying volatility and GARCH and how these ideas are used in risk management.

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Stay tuned to the very end of the video where I might teach you how to spell heteroskedasticity.

But if the volatility is changing from day to day, the VaR must actually also be changing too.

If volatility changes every day, VaR becomes significantly more complicated.

How do we know today's likely volatility? The most common solution to this problem was introduced in 1986 by Tim Bollerslev, whose time-varying volatility technique called the GARCH method, GARCH stands of course for Generalized Autoregressive Conditional Heteroskedasticity, allows us to base our prediction of today's volatility on recent volatility.

The daily volatility estimate using GARCH is a weighted average of past squared returns, just as it was in the constant volatility case.