An empirical approach toward realistic modeling of capital market volatility

Abstract

This paper examines the realized integrated variance of the daily return rate series of S&P 500, Nasdaq and FTSE 100 respectively. The realized integrated variance is defined to be the statistical variance of the market index return rates within a certain time window. In stead of regarding the realized integrated variance as an empirical approximate of the latent spot volatility as formally defined in a mathematical framework, such as GARCH, we treat it as a direct "observable" volatility measure and try to model its dynamics straightforward. First, we find the volatility series is a stochastic jump-decay process rather than being all-over-the-time stationary in each market. Also, under switching bull and bear market conditions, the volatility series exhibits significantly different dynamic characteristics. Secondly, some major market structures, related to volatility mechanism, might have changed due to the hefty usage of options for hedging volatility risk after 1997.