of Economic
Dynamics
Threshold
JeanMichel
and Control
18 (1994) 931955.
heteroskedastic
NorthHolland
models
Zakoian*
Paris, France
December
1992
classjfication:
models;
Asymmetries
in volatility;
Stationarity
C32; C51
1. Introduction
Timevarying
volatility
models have been developed
for a long time to
describe series of prices [e.g., Taylor (1986)]. Historically,
heteroskedasticity
used to be specified as a function of exogenous observable variables. However,
such formulations
proved too restrictive and it was necessary to introduce an
endogenous
dynamic in the specification
of the variabilities.
This progression led to ARCH models (Autoregressive
Conditionally
Heteroskedastic) introduced
by Engle (1982) and to their extensions: GARCH [Bollerslev (1986)] or ARCHM
models [Engle, Lilien, and Robins (1985)]. These
formulations
explicitly model timevarying
conditional
variances by relating
them to variables known from the previous periods. In its classical formulation,
the GARCH
regression model is obtained
by assuming
an autoregressivemoving average equation on an observable variable Y, the conditional
variance
Correspondence
to: JeanMichel
Zakoian,
CREST,
15 Boulevard
Gabriel
Peri, 92245
Malakotf
Cedex, France.
*I should like to thank
and Roger Rabemananjara
01651889/94/$07.00
Christian Gourieroux
and two anonymous
for the empirical example.
1994Elsevier
reserved
932
being expressed
values,
as a linear function
of past squared
innovations
j=I
t2)
k=l
933
size to have different impacts on volatility. Moreover, the multiplicative modelling of volatility does not imply positivity constraints on the parameters. An
important difference with the GARCH is that the innovations are divided by
their conditional standard deviations [using E instead of Z in (2) would certainly
make the model intractable]. As a consequence, persistence in volatility only
depends on the Bj parameters. Therefore, the effect on the volatility of a shock
E on the observable variable seems more difficult to interpret.
The aim of this paper is to propose a new specification of volatility, keeping
the GARCH tractability while allowing for asymmetry. To take the latter into
account we use a more flexible lag structure in the volatility, based on the
positive and negative parts of the innovation process. This process, named
threshold ARCH, is described in section 2 and some of its main properties
(linearity, stationarity) are developed. Section 3 is devoted to inference: maximum likelihood and least squares methods are proposed. In section 4 we make
a comparison of several ARCH and GARCH specifications on the French CAC
stock index. Section 5 concludes. The proofs are given in the appendices.
2. Threshold GARCH
A natural device for introducing asymmetries in volatility is to make it
a function of the positive and negative parts of the innovation process. In
a recent paper, Glosten, Jagannathan, and Runkle (1989) have estimated an
extension of GARCH, in which the conditional variance is written as a linear
function of the squared positive and negative parts of the noise. We adopt
a somewhat different approach, based on a paper from Davidian and Carroll
(1987) about variance function estimation. One of the most interesting results
that they obtain (though variance is allowed to depend on directly observable
variables) is that in the case of nonnormal distributions, absolute residuals yield
more efficient variance estimates than squared residuals. Therefore we do not
square the positive and negative parts of the noise, and we specify the conditional standard deviation instead of the conditional variance. To formalize it, let
E,denote a realvalued discretetime process, sti = (E,_ i, E,_~, . ..) the information set (ofield) of all information through time t, E: = max(s,, 0) and
_
= min(.s,, 0) the positive and negative parts of E,. The Threshold GARCH
Ti, q) process is then given by
Et =
g,z,,
(Z,) i.i.d.,
(3)
EZ, = 0,
VZ, = 1, Z, independent of
Ed
for all t,
(5)
934
0, LY+20,
ai 2 0,
Bi 2 0
for all i.
(6)
Dt =
@O +
i$lxilEtil
i
j=
Pjatj
(7)
As in GARCH
*Model
models
the constraints
by Taylor
can be weakened
[Nelson
(1989).
935
GARCH impose a constant structure at all lags. In the threshold GARCH case,
different lags may yield opposite contributions
as far as asymmetry is concerned
< 0 ). This need of complexity in the
(for example, CI: cc;
>Owhilec(:
cc;
asymmetry
structure
will be illustrated
in section 4. Finally,
exponential
GARCH modelling
implies an ARMA equation for the lna process, which
makes the probabilistic
study very easy. However, it does not provide any linear
equation in any function of E. As a consequence, twostep least squares inference
procedures
are not possible in the exponential
GARCH context. Threshold
GARCH preserves this feature of classical GARCH models, as shown in the
following section.
2.1. Linearity
From
of threshold GARCH
Et =
c&z,+ and
Et+ =
and
the respective
Multiplying
means
= a,E[Z+]
Et  U, = a,E[Z+]
(4) by E[Z]
E; = o,Z;
63)
of the positive
E[E;/E,_]
innovations
and
of
C(;E,Li]
E[Z]
ol(JE[Z]
+ i
i=l
E;;
have
we
yields
+ i
/Ij(ELj
UCj)
U,
j=l
i=l
et =
o,E[Z1.
and
E:
parts are
E;  v, = o,E[Z1.
cCoE[z+] + i [C(;E:_i 
and negative
+ i
jjj(EtYj
Vrj)
0,.
j=l
(9)
Therefore, the vector (E:, E;) is solution of an ARMA(max(p,q),p)
equation.
This is analogous to the GARCH case in which the same property is true for the
(8:) process.
To evaluate whether shocks to variance persist or not, it is necessary to
analyse the stationarity
properties
of the error process. As in the GARCH
context, a general study is difficult. We concentrate
on two important cases: the
threshold ARCH(q) and the threshold GARCH(1, 1).
936
2.2.
Threshold ARCH
is a function
only,
Ot
cl0 +
Ca:.ztti
 C(i&ri.
(10)
i=l
1,
E;dq+
1,
1,
&*_&,I
1,
. . .
E: E: q +
1,
CO, =
b + i
Aio,i
+ vt
with
E[r/,/w,_]
= 0.
i=l
Proof:
See appendix.
Let
A(L)
denote
the
lags
polynomial
U = (l,l, .,. ,O)ER~.
The next property gives a sufficient condition
A(L) = I  CT=iAiL
for widesense
and
stationarity:
V(/(E,)= u[A(l)]
lb,
for
t # s.
See appendix.
Threshold
a0 > 0,
GARCH
a: 2 0,
model sets
2 0. (11)
937
or =
a0 +
wz,lb,1
equation
(12)
See appendix.
it converges
4.
(i) if E[logB(Z,)]
(ii) if E [logB(Z,)]
ProoJ:
See appendix.
In this simple
weakstationarity
case it is also
condition.
possible
to get a necessary
and
sufficient
is:
the weakstationary
See appendix.
The following
property
is analogous
in the GARCH
case.
938
2.5
1.5
0.5
0
1
Fig. 1. Stationarity
conditions
Proposition 6.
strict sense.
Proof:
ARCH(l)
'
assumption).
Region 2: Existence
existence of EE+, EC, Ea, strict stationarity.
Err, strict stationarity.
Region 3: Strict stationarity.
solution
it is stationary
of
in the
See appendix.
and
cc: + al
< 2i3
J.M. Zakoim.
Proposition
7.
c.ondition,for existence
be expressed
Proof.
939
ARCH(l)
process,
a necessary
and suficient
See appendix.
>
Xz ,
3. Estimation
of autoregressive
In this section
we consider
Y, = CpYt1
+ E,,
IVI =c1,
errors
( Yr) solution
of
(13)
where (E,) is given by (3) (4), and (5) with the additional assumption
that the (Z,)
process has a normal distribution. We also suppose that the widesense stationarity conditions are satisfied. Of course, more general regression models might be
considered as well. However, our mode1 seems to be sufficient for many financial
applications
where a somewhat simple but standard assumption
is a random
J.M.
940
Zakoian,
Threshold heteroskedastic
models
3.1. Prediction
properties
prediction
= @Yf,
the modification
v[Yf+,/Y,]
of the Threshold
ARCH(q)
problems
s 2 0.
is in the precision
of the prediction.
We have:
i$l~2smiE[$+i/E~]
E([Yt+s
 E[Yf+S/Y!]]2/Yr}
=
the
i=l
~[Yf+s/Y~] =
CO+ i
doti
the
i=l
3.2. Maximum
likelihood
estimation
log LT(K e) = 
c log
1=q+1
subspace of
conditional
6, 
r=q+1
(&f/d).
(14)
941
Compared
to the GARCH case, it is important
to note that this function is
continuous
in 8, differentiable
with respect to w but not always with respect to
cp because of the presence of thresholds. The maximum likelihood estimator e,
of parameter 8 is then a particular case of Mestimator
based on a continuous,
right differentiable
function. We know that under certain regularity conditions
[Huber (1967), Gourieroux
and Monfort (1989, ch. S)] this estimator is consistent, asymptotically
normal:
JT(& 
&)
J [O, Jl]
(15)
with
a+ioge(r;e,)a+
J = E
0
where a/30
denotes
ae
ioge(r;e,)
a@
pop+
a:]]@_,
,
component
by component,
and d( Y; 0)
At the optimum
we then have
942
J=
Jw J@
[ Joq
conditions.
But better is certainly to apply the
software derive numerically.
asymptotic
precision deduces from matrix J,
blocks:
Joe
with
Here, the difference with the GARCH(q) regression model is the fact that the
second diagonal element Jgv is generally nonzero. Hence, the mean and variance
parameters
are linked and inferences on both types of parameters
cannot be
carried out separately. Again in the symmetric case, the estimators turn out to be
asymptotically
independent.
Proposition 8. For the Threshold GARCH
the estimators eT and 6, are asymptotically
Proof:
See appendix.
of the Threshold
ARCH(q)
Et =
X0 +
i
i=l
[cI+E:~ 
Cr; Eti]
EZ;
+ at [Z;
 EZ;]
. (16)
943
Then we obtain consistent estimators, say 5.r, of the variance parameters c(, by
regressing (&+, E)
, on its q past values and a vector of ones.
In a second step, the mean parameter may be improved taking into account
the form of the variance of the error term a,. This variance may be approached by
Hence a quasigeneralized
with asymptotic
least square
estimator
of cp,
variance
(EZ:)(EZ;)
EZ;
 (EZ;)2
(17)
944
We first estimated
an ARCH process with a short
structure was selected for the conditional
variances:
memory.
A fivelags
ARCH(S):
0: =c(o + CCli&:_i.
i=l
The Berndt, Hall, Hall, and Hausman (1974) algorithm was used to obtain the
estimates. The gradient was computed
numerically.
Parameter
estimates are
insensitive
to various initial conditions
for our sample, making it likely that
global maxima are achieved. The estimation
results are reported in table 1.
First note that the sets of coefficient estimates are quite different from one
period to another. All of them are statistically
significant (except a0 in period
1 and a4 in period 2). The sum of the ARCH parameters
(aI + ... + ~1~)is
substantially
smaller than unity. In every subperiod, conditional
homoskedasticity is rejected.
To catch nonsymmetric
behaviours
in the conditional
variances we then
considered
a Threshold
ARCH specification
with the same length in the lag
structure:
5
TARCH(5):
(18)
i=l
945
parameter
Paraqter
estimates
(standard
errors
in parentheses).
._. 198185
,.
197680
198690
197690
0.09
(0.03)
0.06
(0.01)
0.01
(0.02)
0.33
(0.03)
0.33
(0.03)
0.11
(0.00)
0.27
(0.02)
0.29
(0.02)
0.26
(0.02)
0.48
(0.04)
0.33
(0.01)
0.19
(0.03)
0.16
(0.04)
0.16
(0.03)
0.18
(0.02)
0.07
(0.03)
0.20
(0.03)
0.25
(0.03)
0.17
(0.02)
0.17
0.11
(0.03)
0.05
(0.03)
0.11
(0.02)
0.16
(0.03)
0.03
(0.03)
0.18
(0.03)
0.12
(0.02)
0.14
(0.03)
0.10
(0.03)
0.06
(0.03)
0.11
(0.02)
1.09
0.86
1.24
1.07
Unconditional
std. dev. of Y
aNot significantly
different
Table
TARCH(5)
Parameter
m
197680
Unconditional
std. dev. of Y
aNot significantly
estimates
(standard
errors
in parentheses),
198185
198690
197690
 0.02
(0.02)
0.06
(0.02)
0.05
(0.04)
0.02a
(0.01)
0.35
(0.03)
0.32
(0.03)
0.12
(0.03)
0.28
(0.02)
0.38
(0.03)
0.35
(0.02)
0.54
(0.04)
0.43
(0.0 1)
cp
u:, ff;
parameter
0.08
(0.02)
0.25
(0.03)
0.31
(0.00)
0.19
(0.03)
0.29
(0.00)
0.21
(0.04)
0.24
(0.02)
0.24
(0.00)
0.23
(0.00)
0.24
(0.04)
0.03
(0.00)
0.07
(0.00)
0.11
(0.04)
0.24
(0.00)
0.14
(0.02)
0.15
(0.02)
0.08
(0.00)
0.22
(0.03)
0.20
(0.04)
0.19
(0.04)
0.05
(0.04)
0.13
(0.04)
0.09
(0.02)
0.18
(0.00)
0.17
(0.03)
0.00
(0.04)
0.11
(0.04)
0.08
(0.03)
0.00
(0.03)
0.17
(0.03)
0.07
(0.00)
0.12
(0.02)
0.09
(0.03)
0.19
(0.00)
0.15
(0.04)
0.06
(0.03)
0.06
(0.04)
0.13
(0.03)
0.11
(0.02)
0.10
(0.02)
1.31
different
0.99
from zero at 5% level.
1.41
1.23
946
Once again,
used, as
the estimate
components
COV(O~,E~~)= Eo,E,_~ =
of Eo,
(see Proposition
1) can
be
2 ~~+(EE:_~E:_~+E&E:_~)
i=l
Table 3
Estimated
correlations
between
errors
in parentheses).
198185
198690
197690
 0.15
(0.03)
0.12
(0.03)
0.08
(0.04)
(0.01)
 0.03
(0.03)
 0.02
(0.00)
0.14
(0.00)
 0.00
(0.02)
 0.17
(0.03)
0.02
(0.06)
 0.05
(0.06)
 0.10
(0.02)
0.09
(0.04)
0.06
(0.05)
~ 0.15
(0.05)
 0.07
(0.02)
 0.02
(0.03)
0.35
(0.05)
0.15
(0.05)
0.19
(0.03)
197680
Not significantly
different
0.OOa
94l
Table 4
Parameter
estimates
(standard
errors
in parentheses).
Model
Parameter
1)
TGARCH(1,
1)
EGARCH(l,
GARCH(I,l)
STGARCH(l,
@0
0.056
(0.013)
0.025
(0.013)
0.038
(0.013)
0.039
(0.013)
@I
0.262
(0.017)
0.265
(0.019)
0.262
(0.017)
0.272
(0.017)
%o
0.042
(0.007)
0.043
(0.012)
0.049
(0.017)
 0.225
(0.012)
0.111
(0.020)
0.238
(0.018)
a;
1)
Z, or
21
PI
Not significantly
and negative
corresponding
0.156
(0.009)
0.155
(0.0 I 5)
0.192
(0.019)
0.343
(0.016)
0.807
(0.011)
0.836
(0.018)
0.833
(0.020)
0.958
(0.004)
different
we call it symmetric
threshold
GARCH.
The
GARCH:
EGARCH:
lnc+ = a0 + c(:ZL,
STGARCH:
 cc;Z,,
+ flln&,
estimates
cannot
948
J.M. Zakoian.
Threshold heteroskedastic
models
Table 5
Parameter
estimates
(standard
errors
in parentheses),
Model
Parameter
GARCH
(1,l)
STGARCH(1,
1)
TGARCH(l,
1)
EGARCH(l,
@o
0.010
(0.022)
0.025
(0.021)
 0.007
(0.021)
 0.004
(0.022)
@I
0.337
(0.03 1)
0.331
(0.026)
0.328
(0.029)
0.33 1
(0.029)
lo
0.042
(0.007)
0.045
(0.014)
0.048
(0.017)
 0.240
(0.020)
0.176
(0.016)
0.166
(0.021)
0.113
(0.035)
0.219
(0.033)
0.205
(0.032)
0.376
(0.028)
0.829
(0.029)
0.943
(0.009)
a:
1)
GI, or
a;
B1
0.791
(0.016)
Not significantly
different
0.824
(0.029)
from zero at 5% level.
Table 6
Parameter
estimates
(standard
errors
in parentheses),
Model
GARCH(1.1)
Parameter
a:
STGARCH(1,
1)
TGARCH(1,
1)
EGARCH(l,
0.07 1
(0.019)
0.065
(0.017)
0.059
(0.019)
0.061
(0.019)
0.329
(0.030)
0.326
0.324
(0.028)
0.353
(0.03 1)
0.045
(0.007)
0.05 1
(0.017)
0.056
(0.019)
 0.260
(0.025)
0.143
(0.019)
0.167
(0.026)
0.133
(0.042)
0.326
(0.041)
0.179
(0.037)
0.336
(0.029)
0.806
(0.045)
0.965
(0.006)
0.784
(0.025)
0.794
(0.038)
1)
949
Table 1
Parameter
estimates
(standard
errors
in parentheses).
Model
Parameter
GARCH(l,
@o
1)
STGARCH(l,
1)
TGARCH(l,
1)
EGARCH(l,
0.096
(0.029)
0.063
(0.024)
0.063
(0.029)
0.068
(0.029)
@I
0.103
(0.03 1)
0.121
(0.027)
0.108
(0.029)
0.101
(0.033)
%I
0.07 1
(0.017)
0.058
(0.025)
0.070
(0.029)
 0.174
(0.020)
0.156
(0.018)
0.134
(0.032)
0.08 1
(0.036)
0.157
(0.033)
0.193
(0.038)
0.314
(0.028)
0.831
(0.044)
0.946
(0.012)
a:
1)
5(, or
a;
0.197
(0.027)
Bl
0.847
(0.036)
Table 8
Likelihood
ratios
statistics.
LR
Model
ARCH (5)
TARCH (5)
GARCH (1, 1)
STGARCH
(1, 1)
TGARCH
(1, 1)
EGARCH (1, 1)
197680
198185
198690
197690
119.2
127.6
104.4
107.2
112.3
105.3
158.2
169.7
145.5
144.6
151.5
210.3
180.0
196.2
164.8
165.2
178.9
165.7
469.0
486.5
486.0
490.4
501.2
513.9
compared
model.
other periods. Apart from asymmetry, table 8 also shows that it seems better to
model volatility through standard
deviations
rather than through variances
(although we do not know if the differences are significant).
Another way to assess the quality of the results is to consider the sample
excess Kurtosis for the standardized
residuals C,/6,. Once again we refer to
Nelson (1990b) (with the same comments
as before), who showed that the
greater the error in the volatility estimate, the thickertailed
are the standardized
residuals. As documented
by many previous studies, the models do not fully
account for the observed leptokurtosis
in the series. However, the conclusions
950
.x
ARCH(5)
TARCH(5)
GARCH(1, 1)
STGARCH(1,
1)
TGARCH(1,
1)
EGARCH(1,
1)
kurtosis
coefficient
residuals
197680
198185
198690
197690
3.32
2.64
3.16
3.07
2.83
2.83
2.86
1.95
3.26
3.19
2.78
2.75
1.61
1.19
1.97
1.95
1.48
1.55
2.81
2.29
2.98
2.89
2.48
2.76
5. Conclusion
The threshold model introduced in this paper should provide an effective tool,
simple to use and estimate, for reflecting the asymmetric
relation between
volatility and past returns. Its simplicity is the one of classical GARCH: the
modelling
provides additivity,
linearity, and dependence
of volatility
in the
innovations
magnitude.
Its generality with respect to the treatment of asymmetry is illustrated in the
empirical example. Our results confirm recent evidence that volatility of stock
returns reacts differently to increases and decreases. However, the evidence of
a negative correlation
between past innovations
and the current volatility is far
from being fully supported by our data. Models with one lag in each variable do
confirm this hypothesis (threshold or exponential
GARCH agree on this point),
except for one subperiod. However, threshold ARCH with several lags leads to
a more subtle analysis. Mainly, it provides the possibility
of a nonconstant
structure of asymmetry: the relative impacts of negative and positive shocks on
the current volatility are not the same at all lags. Our data typically illustrate
this possibility,
which leads to moderate the conclusion
concerning
negative
correlations.
951
Appendix
A.I.
= E(E,_kO,_,(tX:z:_,
as
Ed+= a,Z:
Cr;z,l))
E;
and
= E(E,_~cJ_~)(c(:
cc;)EZ+
a,Z;,
from symmetry
and
independence,
= E(~,_~a,_~+~)(cf:
= (4
a;)@;
x;)~~I!?Z+
+ a;)kl
EZ+
by iteration,
EZ+2
k>
_&fk,
1.
4
E[&:/&1_1]
o:E[Z:]
c(o + C C(+&:i i
CO,
i=l
4
 C dli &,_i FCZ:21
i=l
1
>
= i
i=l
Ai[ECO_i  A(l))b]
952
equation
condition
has been
64.1)
of E, follows immediately
Sufficient
Subsequent
0t
part.
by EE: = E&:
+ EE;'
Q.E.D.
Suppose
substitutions
E[logB(Z,)]
= 6 < 0.
... B(Z,_i)UO
64.2)
i=O
a.s. limf~~~logB(Z,_
= 1 for i = 01.
the law of large numbers
gives
1_k) = 6.
Consequently,
a.s. lim[B(Z,_i)
Hence, the existence
. . . B(Z,_i)]i
= es < 1.
(A.3)
of
4, = a.s. lim i
B(Z,_ i) . . .
BtZriJaO
(A.4)
i=O
by application
It is easily
is solution
being
independent
of [a,
(&) is a Markov process. It is also homogeneous
as (Z,) is
strictly stationary,
and it is clear from (A.4) that its law is independent
of t. It
follows that (<,) is strictly stationary.
It remains only to define for all t: E, = &Z,. The (Ed)process is solution of eqs.
(3) and (11). It is obviously a homogeneous
Markov process and the law of E,
does not depend on t. Hence the existence of a strictly stationary
solution.
953
(ii)
Necessary
part.
Suppose
E[log
B(Z,)]
= 6 > 0.
(iii) Uniqueness
of the solution,
< 0.
AS.
to
Proof of Proposition 4
It follows directly from the previous discussion, using the fact that (A.2) writes
6, = B(Z,_,) . . . B(Z,_p)a,_,
in this case.
Q.E.D.
Necessary
part.
solution.
(ii)
Sufficient
independent
part.
We have
1)] E[o, J + E[B(Z,
Suppose
that E[B(Z,)]
positive,
1)]E[a:the condition
J .
is
= 6 < 1.
We have E[logB(Z,)]
I logE[B(Z,)]
I log[E[B(Z,)]Z]2,
using Jensens
inequality.
Then the (5,) process of (A.4) exists. It is clearly stationary in the wide sense as
it is noncorrelated
and
Et: I ~cc;E[B(Z,_~)~
I 2LYa+5
+ B(Z,_1)2B(Z,_2)2
+ ...I
< + CO.
k=O
is a weakstationary
solution.
(E,)
solution
954
(iii)
Uniqueness
of the solution.
process. Then 0, = 5, +
taken in L*. We have
hence
the limit
is
of the stationary
conditions
is in section
A.S(ii).
Q.E.D.
...I 5 k&+f#<
j=O
with 6 = E[B(Z,)k].
Q.E.D.
= 3Eo $1,
k11,
x i Cli(IEt81>0
...
>ILI, ,Gpl
lEtL<O)(
ytil)
i=l
. . . 1IGpll
$W,
x i
Cti(Izt_r>O
lBt_i<O)(
Yti+1)lE,2
i=l
=
xi
3Eo
i=2
Eo
Cli(ley_,>O
1
1
. . . , I~tpll~,_Z
$M,

lariCO)(
ytil)
11
+cc
955
usingthefactthat(l/a:)[l,
IE,~~I, ...,~f_P]~l(Z~~_,,O
 IElmICO)(  Y,,)isan
odd function in E,_ 1 and that this variable has a symmetric conditional
distribution. Now E,[(l/a~)[l,
IE,_~/, . . ..l.z.1]/~~]
is an even function of E,_~ and
Q.E.D.
the same method applies. Iterating the procedure proves the property.
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