On Tuesday, you calculated the volatility of Wednesday as 5% using the GARCH model, which information will make the Thursday volatility become even higher?

Question

BlackTom AI · Accepted Answer

The question asks which piece of information would cause Thursday's volatility to rise, given that Wednesday's volatility was computed as 5% under a GARCH framework.
Option A: 'Return on Tuesday very low' — A low Tuesday return by itself does not imply an increase in Thursday volatility. In GARCH models, current volatility is affected by past squared returns and past volatility; a low Tuesday return would contribute less to the next period's volatility, not more, all else equal.
Option B: 'Return on Wednesday very high' — This directly links to the GARCH mechanism: a large absolute return on Wednesday increases the forecasted conditional variance for Thursday through the ARCH term (the impact of the squared return). A very high Wednesday return tends to raise the next period's volatility, making Thursday more volatile.
Option C: 'Return on Thursday very low' — The value of Thursday's return cannot influence Thursday's own volatility forecast for that same period in the standard GARCH specification; volatility is updated based on past information, so a low Thursday return would be a consequence, not a driver, of the forecast, and thus does not explain an increase in volatility for Thursday itself.
Option D: 'None of the above' — Since there is at least one scenario among the options that would raise Thursday's volatility (namely a very high Wednesday return), this choice is not correct.
In summary, the mechanism is that larger past returns—in particular, a very high return on Wednesday—feed into the volatility update and push the next period’s (Thursday's) volatility higher, whereas other options either do not influence or would dampen the volatility forecast.

BU.230.730.81.SP25 Final Exam- Requires Respondus LockDown Browser

On Tuesday, you calculated the volatility of Wednesday as 5% using the GARCH model, which information will make the Thursday volatility become even higher?

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