366 Int. J. Management Practice, Vol. 7, No.

4, 2014

Modelling stock return volatility: comparative

evidence from selected emerging African and
Western developed markets

William Coffie*
Department of Finance, Accounting & Business,
Wolverhampton Business School,
Faculty of Social Sciences,
University of Wolverhampton,
Nursery Street, City Campus, Wolverhampton, WV1 1AD, UK
Email: w.coffie@wlv.ac.uk
*Corresponding author

Osita Chukwulobelu
Birmingham City Business School,
Birmingham City University,
Galton Building, Franchise Street,
City North Campus, Perry Barr, Birmingham, B42 2SU, UK
Email: osita.chukwolubelu@bcu.ac.uk

Abstract: This paper investigates volatility persistence by comparing evidence

from selected emerging African and Western developed markets, taking into
account the rate of volatility decay. Generalised Autoregressive Conditional
Heteroscedasticity (GARCH) and GARCH-in-mean (GARCH-M) models
are used to estimate volatility persistence and risk premium for these markets.
The results presented here suggest that there is volatility persistence in
the four emerging African markets and the five developed markets. The
study concludes that volatility risk exists in these markets and investors would
require compensation for bearing this type of risk.

Keywords: African stock markets; developed markets; return volatility;

GARCH; GARCH-M.

Reference to this paper should be made as follows: Coffie, W. and

Chukwulobelu, O. (2014) ‘Modelling stock return volatility: comparative
evidence from selected emerging African and Western developed markets’,
Int. J. Management Practice, Vol. 7, No. 4, pp.366–379.

Biographical notes: William Coffie has a cumulative work experience of

almost 15 years, which straddle four very important sectors in the public and
private sectors – the academia, local government, charity and industry. He
teaches at both undergraduate and postgraduate modules in Finance,
Econometrics and Accounting. His research interest lies in asset pricing &
portfolio theory, volatility forecasting & correlations, time-series & cross-
sectional analysis, stock market efficiency, Africa and emerging markets
finance and cost of capital.

Copyright © 2014 Inderscience Enterprises Ltd.

 Modelling stock return volatility 367

Osita Chukwulobelu currently is a Senior Academic (Associate Professor) in

Finance and Head of Finance Subject Group at Birmingham City Business
School. He is also the Faculty Director of Collaborative Programmes (Africa
and South East Asia). He has a cumulative work experience of more than
33 years, which straddle three very important sectors in the public and
private sectors – the academia, management consultancy, and international oil
marketing.

1 Introduction

Ability to predict and understand the dynamics of stock return volatility in the second-
order moment of financial asset returns is vitally important in financial and economic
decision-making. The academic literature recognises that financial asset returns exhibit
leptokurtosis, skewness and volatility clustering (Hsu et al., 1974; Hagerman, 1978;
Lau et al., 1990; Kim and Kon, 1994). This has been typified by academics as the
volatility persistence and practitioners regard this as the risk or uncertainty.
Until recently, most of the existing empirical evidence on the relationship between
the conditional mean and the conditional volatility of the excess returns on assets has
come from the developed markets, but with contradictory results. For example, French
et al. (1987) and Campbell and Hentschel (1992) found positive relationship between
excess return and conditional variance, Fama and Schwert (1977), Campbell (1987),
Breen et al. (1989), Turner et al. (1989), Pagan and Hong (1991), Nelson (1991) and
Glosten et al. (1993) reported negative relations, while Chan et al. (1992) found no
significant variance effect in their study. Glosten et al. (1993) argue that these conflicting
results are due to the different models used by the studies in modelling conditional
variance. They note that ‘most of the support for a zero or positive relation comes from
studies that use the standard GARCH-M model of stochastic volatility’ while the studies
which document negative relationships employed alternative models such as EGARM-M
used by Nelson (1991).
Furthermore, empirical studies documented weaknesses with the application of
GARCH models to high-frequency data. For example, Lamoureux and Lastrapes (1990)
using a Monte Carlo simulation process show that GARCH overestimate persistence in
variance of daily US returns data as it fails to account for deterministic structural shifts in
the volatility process. Similarly, Hamilton and Susmel (1994) employ GARCH via
Markov-switching approach to model a conditional volatility process of stock returns that
is subject to regime shifts. Their evidence shows that shocks to volatility are less
persistent when structural changes are accounted for.
The GARCH (1, 1) model measures the degree to which shocks to current volatility
are important for predicting future volatility. First (mean) and second (variance) moment
equations are used to define GARCH (1, 1) model. The return process, rt, is captured by
the mean equation which is made up of the conditional mean, μ, which might encompass
terms of autoregressive (AR) and moving average (MA) and error term, εt, that follows a
conditional normal distribution with mean of zero and variance σ2. The conditional
variance is kept strictly positive by imposing the inequality restrictions on the parameters
368 W. Coffie and O. Chukwulobelu

ω = 0 and α, β ≥ 0. The condition of GARCH (1, 1) has the valuable quality that
fluctuation in decay in volatility is at a constant rate and the pace of decay is measured by
the forecast of α + β.
This study investigates and compares the volatility characteristics of African
emerging and Western developed markets and also provide how volatility contributes to
asset risk. We also provide a new perspective on volatility risk by estimating the half-life
of decay. The rest of the study is organised as follows: Sections 2 and 3 review
relevant academic literature and address the methodological approach, respectively,
while Sections 4 and 5 provide analysis of results and conclusion, respectively.

2 Literature review

The error variance has been found to change over time against the traditional assumption
of homoscedasticity in many time-series analyses. For example, empirical evidence
on the statistical characteristics of time-series stock market returns, as documented by
Hsu et al. (1974), Hagerman 1978; Lau et al. (1990), and Kim and Kon (1994), show that
the series are not only leptokurtic but also exhibit high volatility clustering or pooling.
This ‘persistence in volatility’ is the tendency for volatility in asset returns to occur
in bunches, with large positive (negative) returns expected to follow large positive
(negative) swings in asset prices and vice versa. Furthermore, Black (1976), Christie
(1982), Nelson (1988), Pagan and Hong (1991) and Glosten et al. (1993) reported
the leverage effect in the volatility of asset returns, which describes the second tendency
for volatility to rise more following a large price fall than following a price rise of the
same size.
In order to capture these statistical characteristics of time-series data, Engle (1982)
proposed the Autoregressive Conditional Heteroscedasticity (ARCH) model, which uses
past errors or disturbances (for up to q lags) to model the conditional variance. For
example, under the ARCH (1) model, the autocorrelation in volatility is modelled by
allowing the conditional variance of the error term to depend on the value of one lagged
squared error, that is (insert the equation here). Brooks (1998), however, argues that the
ARCH (q) models bring with them ‘a number of difficulties’ which have ensured their
limited application in empirical studies over the last decade or more. For instance, in the
face of empirical evidence that higher orders of the ARCH models are required to capture
all of the dependence in the conditional variance, how should researchers decide on the
number of lags of the squared errors (the value of q) that should be specified? Engle’s
(1982) solution to this problem was deemed to be arbitrary and therefore unsatisfactory.
Bollerslev (1986) overcame the problem and the other empirical difficulties in Engle’s
(1982) ARCH model by proposing the popularly known Generalised Autoregressive
Conditional Heteroscedasticity (GARCH). Essentially, this suggests that time-varying
volatility is a function of previous own lags (past volatilities) and past lagged square
errors, generally expressed as GARCH (p, q). French et al. (1987) and Franses and Van
Dijk (1996) show that, unlike the ARCH model, higher GARCH models are not required
to model the changes in conditional variance over a long period of time and that the
GARCH (1, 1) is sufficient to achieve this.
Nelson (1991) identified three reasons for the shortcomings of GARCH models in
modelling the relationship between conditional variance and asset risk premia. Firstly, by
 Modelling stock return volatility 369

assumption, the models rule out the possibility of a negative correlation between current
returns and future return volatility, yet as we note earlier, this possibility is documented
by Black (1976), Christie (1982) and Glosten et al. (1993). This is the tendency for
volatility to rise in response to bad news (excess return lower than expected) and to fall
in response to good new (excess return higher than expected). Intuitively too, falling
stock prices lead to increasing leverage ratios, increasing uncertainty to shareholders’
returns, and hence generating more volatility in the assets returns. Rising stock prices
will have the opposite effects. The ARCH/GARCH models are unable to account for the
presence of these asymmetric and leverage effects in conditional time variance. Instead,
the models ‘assume that only the magnitude and not the positively or negativity of
unanticipated excess returns determines future volatility’ Nelson (1991). Secondly, in
modelling volatility the GARCH models impose non-negativity restrictions on the model
parameters to ensure that the conditional variance remains non-negative for all time
periods with probability of 1. However, this condition is also often violated by the
estimated coefficients. And thirdly, with GARCH models, it is difficult to interpret
whether shocks to volatility persist or not as the usual norms for measuring persistence
often disagree. As a result of these weaknesses, Nelson (1991) suggests a ‘new
approach’, the EGARCH-M models as the better alternatives for modelling conditional
volatility.
Consequently, Glosten et al. (1993), in their study of the US market, employ a variety
of modified GARCH-M and EGARCH-M to allow for (a) seasonal effect in volatility
(b) the different impacts of positive and negative shocks on conditional variance, and
(c) the inclusion of nominal interest in the conditional variance as a predictor of future
volatility in excess returns in line with Fama and Schwert (1977) and Campbell (1987).
They evaluated seven different specifications of their modified GARCH-M model. Their
results support previous evidence of a statistically significant negative relationship
between conditional mean and conditional variance found by Fama and Schwert (1977),
Campbell (1987), Breen et al. (1989), Turner et al. (1989), Pagan and Hong (1991),
Nelson (1991) and Glosten et al. (1993), but also show that the conditional variance
of monthly returns on the US market may not be as persistent as was previously thought.
Instead, the results suggest that positive unanticipated returns (positive residuals)
appear to lead to a downward revision of the conditional variance whereas negative
unanticipated returns (negative residuals) result in an upward revision of conditional
volatility. Furthermore, the results indicate that the risk-free rate contains information
about future conditional volatility within the modified GARCH-M framework as well as
a significant seasonal effect in volatility. These findings also held when Glosten et al.
(1993) allowed for excessive skewness and kurtosis in their results by evaluating
different specifications of the modified EGARCH-model. Hence, they concluded that
‘our results are consistent with the negative relation between volatility and expected
returns reported by previous studies cited earlier and that the standard GARCH-M model
is misspecified’. However, in a more recent study of ten industrialised stock markets,
McMillan and Ruiz (2009) found that modified GARCH models that allow for variation
in the mean provide improved volatility forecasting performance over a long period of
time.
Empirical evidence on the conditional volatility of asset returns in emerging markets
is limited and largely come from Asia and Latin America. Chiang and Doong (2001), for
370 W. Coffie and O. Chukwulobelu

example, examined the time-series behaviour of returns from seven Asian markets,
including Hong Kong, Malaysia, the Philippines, Singapore, South Korea, Thailand and
Taiwan. Firstly, employing the methodology of French et al. (1987), they found that four
out of the seven markets (South Korea, Philippines, Thailand and Hong Kong) exhibited
significant relationships between stock returns and unexpected volatility, and that in
general, unexpected volatility has a more significant effect on stock returns than does the
expected component. Then using a Threshold Autoregressive GARCH (1,1) to analyse
the relationship between stock markets and time-varying volatility, they reported that the
GARCH parameters are highly significant in the daily return series of all the seven Asian
markets studied but very little GARCH effect was found on the monthly data. Very
significantly too, their results strongly rejected the hypothesis of asymmetric effect in
conditional volatility.
Ortiz and Arjona (2001) examined the time-series characteristics of six major Latin
American markets including Argentina, Brazil, Chile, Colombia, Mexico and Venezuela,
using several GARCH (p, q) models, including their exponential and GARCH-in-mean
extensions. The study covered the five-year period from 1989 to 1994 and was based on
weekly return data expressed in US dollar and the respective local currencies. Firstly,
Ortiz and Arjona (2001) analysed the stochastic characteristics of the returns on the six
markets to determine the nature and extent of departure of the distributions from
normality and independence. They reported that the dollar returns were consistently
lower than the local returns in each of the period covered by their study, and also had
higher associated standard deviations compared to the volatility of the returns in the local
currencies. More significantly, they found that both the dollar and local currency weekly
returns of all the six markets studied were time dependent, heteroskedasticity and
asymmetric, with both right and left skewness discernible, but leptokurtic in all cases.
Ortiz and Arjona (2001) then proceeded to test different conditional heteroscedasticity
volatility models for each market. Given the differences in the stochastic characteristics
of the markets, they employed different GARCH models for the different markets:
for Argentina GARCH(1,3), Brazil GARCH(2,2), Chile GARCH(1,3), Colombia
EGARCH(1,1), Mexico GARCH(1,2), and Venezuela EGARCH(3,3) & GARCH(1,1).
Not surprisingly, Ortiz and Arjona (2001) found that no single GARCH model was able
to describe the stock returns volatility in these markets. Instead, they report that ‘different
GARCH models are more appropriate for each country’, and that ‘the best models seem
adequate’. For Venezuela, however, they found that the EGARCH(3,3) and GARCH(1,1)
led to mixed results, which raises the question of why the researchers did not evaluate the
performance of both GARCH and E-GARCH-M models for the other five markets as
well. Surprisingly though, they found that the one lag return has a significant impact on
current return at the 1% level, with negative beta coefficient in all cases.
Leon (2007) is the only volatility study on African markets known to us. Leon
examined the relationship between stock market returns and volatility on the Bourse
Regionale des Valeurs Mobilieres (BRVM), which is the Regional Financial Exchange
for the eight French-speaking West African countries that form the West African
Economic and Monetary Union. Using weekly returns over the period January 1999 to
July 2005 and EGARCH-in-mean model, Leon reported a positive but statistically non-
significant relationship between conditional market returns and conditional volatility; and
found that market volatility was higher during market booms than when market declines.
 Modelling stock return volatility 371

Both results are inconsistent with developed market evidence of significant positive
relations found by French et al. (1987) and Campbell and Hentschel (1992), and the
leverage effect documented by Nelson (1991).
Against this background, our paper investigates the volatility properties of four
emerging African stock markets including Nigeria, Ghana, Morocco and Egypt compared
with five developed markets consisting of France, Germany, the UK, USA and Japan.
Nigeria and Ghana are chosen because they are the main stock exchanges in English-
speaking West African region, while Morocco and Egypt straddle both North Africa and
Arab markets, which rarely receive any attention in the empirical literature. Our study is
important, because it not only helps to build the body of the current limited empirical
evidence on the nature of conditional volatility in emerging African markets, but also
provides prospective domestic and international investors with a better awareness of how
shocks in these markets influence volatility across time, and hence the extent of return
predictability or lack of market efficiency in these African markets. Furthermore,
the findings here will have important implications in terms of asset pricing, portfolio
allocation and management of risk as the ability to correctly forecast volatility affects
these aspects of investment analysis and portfolio management. Besides, we provide a
new perspective on the volatility characteristics of the markets by estimating the half-life
of volatility persistence in these markets.

3 Data and methodology

3.1 Sources of data and calculation of market returns

The daily stock price indices data used in this study are obtained from Standard &
Poor/International Finance Corporation (S&P/IFC) and Reuters DataStream. These two
sources are used for largely because they are very organised and comprehensive sources
of stock price data, providing readily accessible and reliable data on emerging equity
markets than most other sources. For example, S&P/IFC EMDB (Emerging Market
Data Base) was the first database, from 1975, to track comprehensive information and
statistics on emerging stock market indices. The S&P/IFC global indices, used in this
study, do not impose restrictions on foreign ownership and include sufficient number
of stocks in individual market indices without imposing float or artificial industry-
composition models on markets. Similarly, Thomson Reuters DataStream is widely
recognised for providing accurate and timely data on developed markets, and has
traditionally made error corrections to historical data provided; it can be substantiated
through published research documentation. Non-updated estimates are auto-filtered and
consequently auto-stopped. This is to ensure the highest quality of data. Additionally,
both the S&P/IFC database and Reuters DataStream are attractive because they have
been adjusted for all capital changes as well as the effects of corporate restructuring such
as merger, acquisition and spin offs/demerger as well as being free from data backfilling
and survivorship bias.
The equity indices returns, used in this study, are calculated as:

rmt  ln  t *100
p
 (1)
 pt 1 
372 W. Coffie and O. Chukwulobelu

where rmt is the market return, pt and pt-1 are natural log returns of contemporaneous and
one period lagged equity price indices, respectively. Natural logarithm is preferred as it
computes continuous compound returns.
Table 1 provides further details of the data used in this research including the types of
the stock indices, the time period of the data for each market (and hence sample
observations), and currency of denomination. All the indices used in this study are the
benchmark indices in their respective stock markets.
Table 1 Stock market data profile

Type of Name of Period of No of Source of

Country Currency
Index Index data Observation Data
Weighted index
Hermes Egyptian S & P/IFC
Egypt market 1996–2008 3350
Financial Index Pound BMI
capitalisation
Weighted index
GSE All S & P/IFC
Ghana market Cedi 1996–2013 4589
Share Index BMI
capitalisation
Weighted index
S & P/IFC
Morocco market MASI Index Dirham 1997–2013 4304
BMI
capitalisation
Weighted index
NSE All S & P/IFC
Nigeria market Naira 1995–2013 4719
Share Index BMI
capitalisation
Weighted index
France market CAC 40 Euro 1987–2013 6800 DataStream
capitalisation
Weighted index
Germany market DAX 30 PI Euro 1965–2013 12,675 DataStream
capitalisation
Weighted index
TOPIX S & P/IFC
Japan market Yen 1989–2013 6284
Composite BMI
capitalisation
Weighted index
S&P S & P/IFC
USA market US Dollar 1964–2013 12,937
500 Index BMI
capitalisation
Weighted index
UK Pound
UK market FTSE 100 1978–2013 9262 DataStream
Sterling
capitalisation

3.2 Summary statistics

As expected, return is very high in emerging African stock markets. The two West
African markets registered the highest mean returns at 0.0596% and 0.0513% for Nigeria
and Ghana, respectively; while the North African markets of Egypt and Morocco record
the lowest mean returns at 0.0416% and 0.0343%, respectively. Compare with African
stock markets, the G-5 countries record low mean returns. Among the G-5 markets, the
UK and USA record the highest mean returns at 0.0292% and 0.0243%, respectively,
while Japan registered a negative return of 0.0115%.
 Modelling stock return volatility 373

Table 2 Descriptive statistics

Jarque-Bera
Country Mean SD Skewness Kurtosis
(p-value)
Egypt 0.0416 1.4781 –0.9721 19.0640 36547.5**
Ghana 0.0513 0.9726 4.1500 119.0983 2590436**
Morocco 0.0343 0.7941 0.5537 41.1139 260732.0**
Nigeria 0.0596 1.0392 –0.0168 6.1250 1920.4**
France 0.0147 1.4004 –0.1389 8.4767 8520.1**
Germany 0.0225 1.2186 –0.2497 10.8803 32927.6**
Japan –0.0115 1.3152 –0.1443 9.3925 10721.3**
USA 0.0243 1.0193 –1.0364 31.0292 425806.2**
UK 0.0292 1.1065 –0.5272 24.5741 180050.2**
Notes: The mean, standard deviation, skewness, kurtosis and Jarque-Bera statistics are
shown for each market.
** denotes statistical significance at 1 per cent level.
Surprisingly, developed markets exhibit more volatility, as measured by standard
deviation, than the African stock markets (with the exception of Egypt). This contradicts
Harvey’s (1995) results, which conjecture that there is low volatility in developed
markets. Among the four African stock markets, Egypt registered the highest level of
volatility (as measured by standard deviation) at 1.4781%; while Nigeria offers low
volatility at 1.0392% but with higher return compare to Egypt. Amongst G-5 countries,
with the exception of Japan, France offers the lowest mean returns of 0.0147%; however,
it has the highest volatility of 1.4004%. Furthermore, the USA recorded the lowest
volatility amongst the G-5 at 1.0193% with relatively high mean return.
The evidence shows that the distribution for all the markets is non-normal. For
example, Ghana and Morocco are positively skewed, while Egypt, Nigeria, France,
Germany, Japan, USA and UK are negatively skewed. Each of these time series is fat
tailed as seen in the significant kurtosis well above the critical value of 3. The Jarque-
Bera (JB) which tests the joint hypothesis that the data used in this study are from normal
distribution, with skewness of 0 and kurtosis of 3, is rejected, as demonstrated by
statistically significant JB statistics at the 1% level for all the markets.

3.3 Empirical framework

In this study, heteroscedastic conditional volatility of stock return, rt, is modelled using
GARCH (1, 1) as follows:
rt     t , (2)
the return process, lnrt, is captured by the mean equation which is made up of the
conditional mean, μ, which encompass terms of autoregressive (AR) and moving
average(MA) and error term εt.
 t t 1  N  0,  t2  ,  t2  ht (3)

ht     t21   ht 1  t (4)
ω > 0; α ≥ 0; β ≥ 0; α + β ≥ 0.
374 W. Coffie and O. Chukwulobelu

where lnrt is the continuous compound stock return, N represents the conditional normal
density with mean and variance ht and Ωt–1 is the information set available up to t–1, ω is
constant variance and vt is error of the empirical variance equation. The size of the
parameters, α and β, determines the short- and long-run dynamics of the resulting
volatility time series. A large β, i.e. close to 1, coefficient indicates that shocks to
volatility take a long time to decay; thus, volatility is considered to be persistent and a
large α means that volatility reacts quite intensely to market movements and represents
short-run persistence of shocks. Volatility persistence is also measured by α + β, that is,
the degree at which fluctuation to current volatility remains vital for a long-term in the
future. The persistence of fluctuations to volatility becomes greater as this sum move
towards 1 (i.e. unity). Nevertheless, when α + β = 1, then every fluctuation to volatility is
considered to be permanent. When persistence in volatility is permanent, it means that
current period volatility is important in forecasting future volatility. Volatility is
considered to be explosive when the sum of α and β is greater than 1. This implies that
fluctuation to volatility in one period will lead to even a greater volatility in the next
period (see e.g. Chou, 1988).
French et al.’s (1987) results assert that volatility is actually a priced risk factor and
not just a data characteristic problem. Therefore, the underlying theory of the GARCH
model is that investors should be rewarded for bearing additional risk by gaining a higher
return. To operationalise this, Engle et al. (1987) GARCH-in-mean (or GARCH-M)
model, where the conditional variance term enters into the conditional mean equation, is
applied as follows:

rt  t ˆht t (5)

where ht is the conditional variance of rt. This set-up, therefore, makes the required rate
of asset return at time t linear in its risk as measured by ht. If δ is positive then increased
risk resulting from heteroscedasticity in the conditional variance leads to a rise in the
mean return; thus, δ can be interpreted as a risk premium which compensates for
volatility risk.
The half-life measures the number of days at which a shock to volatility will decay to
half of its original size and this is computed as:

  0.5 
  log   (6)
     
Bollerslev and Woodridge (1992) heteroscedasticity consistent covariance is used to
address conditional non-normality in residuals.

4 Empirical results and analysis

The GARCH model is characterised by the following three fundamental propositions: (a)
ω = 0 and α, β ≥ 0 to ensure that the conditional variance is strictly positive in relation to
expected stock return. However, reported empirical evidences are contradictory. For
example, French et al. (1987) and Campbell and Hentschel (1992) found positive
relationship between excess return and conditional variance, while Fama and Schwert
(1977), Campbell (1987), Breen et al. (1989), Turner et al. (1989), Pagan and Hong
(1991) and Nelson (1991) found a negative relation; (b) shocks to volatility decay at
 Modelling stock return volatility 375

constant rate and the speed of decay is measured by the estimate of α + β; (c) the sum of
α and β measures volatility persistence (i.e. the degree to which shocks to current
volatility remains important for a long period in the future). The persistence of shocks to
volatility becomes greater as the sum approaches 1 (or unity) and shock to volatility is
considered to be permanent if the sum is equal to 1 (Engle and Bollerslev, 1986). As this
sum becomes greater than 1, then volatility is explosive, i.e. shock to volatility in one
period will result in even a greater volatility in the subsequent period (Chou, 1988).
By summing up α (ARCH term) and β (GARCH term), as can be seen from Table 3,
the proposition that, α, β ≥ 0, is supported by the results of all nine stock markets. The
sum of α and β for all the four African stock markets and the five major markets are
positive which is consistent with French et al.’s (1987) and Campbell and Hentschel’s
(1992) results. However, by disaggregating the model, Ghana exhibits negative
coefficients of the conditional (ARCH) variance term. Previous tests of the relation
between stock return and conditional variance using ARCH model have documented
negative relationships (Fama and Schwert, 1977; Campbell, 1987; Breen et al., 1989;
Turner et al., 1989; Pagan and Hong, 1991; Nelson, 1991). This negative relation
between return and conditional variance is buttressed by Black (1976), who found a
negative correlation between current returns and future returns volatility.
Table 3 GARCH (1, 1), GARCH-M and fractional decay estimates

ω α β α+β Ψ δ
0.009 0.055 0.946 1.001 0.117
Egypt N/A
(2.349)* (6.237)** (115.061)** [0.811] (2.916)**
0.531 –0.003 0.626 0.623 0.111
Ghana 1.46
(1.152) (–9.023)** |(1.818) [0.273] (1.684)
0.995
–1.18E-05 0.003 0.998 0.123
Morocco (5122.601)* 346.23
(–11.095)** (4.829)** [0.001] (3.242)**
*
0.004 0.211 0.819 1.030 0.049
Nigeria N/A
(2.275)* (11.888)** (63.205)** [0.000] (2.046)*
0.034 0.092 0.891 0.983 0.095
France 40.43
(4.080)** (8.148)** (73.306)** [0.001] (1.945)
0.021 0.103 0.886 0.989 0.113
Germany 62.67
(4.817)** (8.224)** (80.778)** [0.006] (3.503)**
0.036 0.107 0.876 0.983 0.068
Japan 40.43
(5.611)** (8.939)** (75.062)** [0.001] (1.605)
0.005 0.069 0.928 0.998 0.064
USA 346.23
(5.329)** (6.373)** (98.847)** [0.411] (2.625)**
0.019 0.023 0.959 0.982 0.037
UK 38.16
(2.199)* (2.473)* (61.186)** [0.028] (0.626)
Notes: Numbers in parentheses ( ) are t-statistics. Half-lives, Ψ are computed as log
([0.5]/[α+β]).Under column five, p-values in [ ] are from a Wald test that
α + β=1. For Egypt and Nigeria, the half-life cannot be computed and
interpreted, as the half- life approaches infinity, as α + β→1. They are denoted
NA to show that the method used is not applicable.
** denotes statistical significance at 1 per cent level.
* denotes statistical significance at 5 per cent level.
376 W. Coffie and O. Chukwulobelu

Moreover, it is vitally important to analyse the statistical significance of the ARCH

and GARCH coefficients in relation to returns since the results obtained could have
occurred out of chance. The test of significance was set at 1% (p-value with **) and 5%
(p-value with *) levels and the results, as in Table 3, show that the ARCH term exhibits
statistically significant relationship between volatility of all nine stock markets and
(ARCH term) conditional variance. Similarly, the results, as in Table 3, show that the
GARCH term is statistically significant in all stock markets at the 1% and 5% levels,
with the exception of Ghana which is significant within the 10% level. The Wald
coefficient test, that is α + β = 1, shows that the impact of volatility is significant in
Morocco, Nigeria, France, Germany, Japan and UK stock markets at the 1% and 5%
levels.
However, persistence of volatility, as measured by the sum of α + β, varies
considerably for the four African stock markets and five industrialised markets. In
Nigeria, volatility persistence is explosive at 1.03, while volatility persistence in Egypt is
permanent, which is equal to 1.00. For all other markets α + β < 1. For instance, among
the remaining two African stock markets, Morocco shows the greatest persistence in
volatility at 0.998 as the sum of α and β is close to 1, while Ghana records the lowest
level of volatility persistence at 0.623. Morocco’s high volatility persistence translates
into a half-life of 346 days. This implies that a shock to volatility in the past will be
significant in predicting future volatility over a prolonged period of time in Morocco.
While in Ghana the low degree of volatility persistence is equivalent of a half-life of
1.5 days. Meanwhile, the results obtained in Table 3 show an evidence of high volatility
persistence in all five industrialised markets. The USA shows the highest level of
volatility persistence at 0.998 and this is translated into a half-life of 346 days.
Comparatively, among the five industrialised stock markets, the UK has the lowest level
of volatility at 0.982 with a half-life of 38 days. This means that shocks to volatility in
USA will diminish to half of its original size in just about one year, while shocks to
volatility in UK will decay to half of its original size in around five weeks. In markets
where volatility is explosive, as in the case of Nigeria, and permanent, as in the case of
Egypt, the half-life cannot be interpreted as this approaches infinity, as α + β → 1.
Therefore, volatility persistence is considered very large for Nigerian and Egyptian stock
markets. McMillan and Thupayagale (2009) found similar evidence for Nigeria and
Zimbabwe, where the half-life of these stock markets could not be interpreted as they
approach infinity. Per GARCH restriction, the variance constant, ω, should be 0. As in
Table 3, this condition is violated by the evidence. The coefficients of the variance
constant, ω, for all the stock markets (with the exception of Morocco whose constant
variance is less than 0) are greater than 0. The largely lower degree of volatility
persistence in Ghana stock market and hence, relatively shorter half-life in contrast to the
remaining three African stock markets and the five industrialised markets may reflect the
differences in industrial and structural compositions of these stock markets. For instance,
trading in Ghana stock market is fragmented and symbolised by thin trading effects
which cause shocks to volatility to disappear fairly quickly.
Following the evidence as above, it was found that there is a correlation between
return and volatility in all the nine stock markets; and GARCH is specified in the mean
equation to estimate volatility risk premium. There are two fundamental propositions
describing the GARCH-M model (a) that, δ > 0, to ensure that the conditional variance is
interpreted as risk premium; (b) investors should be rewarded if δ is positive. Per
evidence in Table 3, propositions (a) and (b) are supported. The results show that the
 Modelling stock return volatility 377

volatility premium for all nine stock markets is positive, in line with French et al.’s
(1987), Campbell and Hentschel’s (1992), Guo and Neely’s (2006) results. The positive
premium suggests that investors in these markets are rewarded for taking up additional
volatility risk. Investors investing in these stock markets will expect additional
compensations for volatility risk. Besides, corporations should capture this market-wide
risk when determining cost of capital for investment appraisal purposes.

5 Conclusions

The paper investigates volatility persistence by comparing evidence from selected

emerging African and Western developed markets, taking into account the rate of
volatility decay. Descriptive statistics shows that volatility (as measured by standard
deviation) is high among the developed markets, and, as expected, mean returns are high
for African markets. The sum of α + β for all nine stock markets is positive in support of
the fundamental proposition of the GARCH model. Volatility risk premium, δ, for all
nine stock markets is positive in line with the fundamental proposition of the GARCH-M
model. The positive premium suggests that investors in these markets are rewarded for
taking up additional volatility risks – a proxy for country-specific risk (i.e. country
variance or country idiosyncratic risk). This means in allocating portfolios fund managers
and/or investors should go beyond the mean-variance analysis in regard to these markets
and look into information about volatility, correlation, skewness and kurtosis (see e.g.
Bekaert et al., 1996). This evidence contradicts the assertion of international CAPM
which says that international investors can enter and leave any market anywhere in the
world with reasonable certainty and a minimum transaction costs.
Cost of equity capital is expected to be high in these markets due to compensation for
additional volatility risk. This implies that additional burden is placed on firms seeking to
raise finance from domestic capital markets to fund expansion and to support their
overseas capital investments.
Given the predictability of these stock markets expected returns, with shocks that
are country-specific, and no synchronous effect, these markets can be very good avenue
for international portfolio diversification where international investors are somehow
guaranteed with predictable good returns. From the viewpoint of international investors,
there is considerable evidence to show that there is lack of integration among the African
and the developed stock markets as highlighted by the volatility risk premium (that is,
country risk premium). This suggests that investing in these countries would be subject to
variable levels of transaction costs. Nevertheless, significant benefits can be obtained by
clearly including volatility risk premium into asset pricing model that would capture the
pattern of returns in these markets and improves direct foreign investment flow through
equity and taking up stakes in listed companies.
It is also of the view that this result is an interesting one which contributes to the
growing literature on volatility in emerging markets, particularly, in Africa, among
academics and practitioners as it is one of the first studies. It is hoped that the results here
will initiate a new dimension for the ongoing volatility debate in emerging stock markets.
378 W. Coffie and O. Chukwulobelu

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