Risk and Volatility: Econometric Models and Financial Practice
Risk and Volatility: Econometric Models and Financial Practice is an important paper on volatility and volatility clustering. Rather than random, the market’s most volatile days tend to cluster together in the same time period. Efficient Market Hypothesis assumed market returns are random. Instead, market returns cluster – prices drift in a direction.
Nobel Lecture, December 8, 2003
by
Robert F. Engle III
New York University, Department of Finance (Salomon Centre), 44 West
Fourth Street, New York, NY 10012-1126, USA
Abstract
The advantage of knowing about risks is that we can change our behavior to avoid them. Of course, it is easily observed that to avoid all risks would be impossible; it might entail no flying, no driving, no walking, eating and drinking only healthy foods and never being touched by sunshine. Even a bath could be dangerous. I could not receive this prize if I sought to avoid all risks. There are some risks we choose to take because the benefits from taking them exceed the possible costs. Optimal behavior takes risks that are worthwhile. This is the central paradigm of finance; we must take risks to achieve rewards but not all risks are equally rewarded. Both the risks and the rewards are in the future, so it is the expectation of loss that is balanced against the expectation of reward. Thus we optimize our behavior, and in particular our portfolio, to maximize rewards and minimize risks.
The paper goes on to discuss volatility clustering. Click HERE.
