parameters than in the case of ARCH and permits the conditional volatility to be an

ARMA (p,q) process:

𝑞 𝑝
2
ℎ𝑡 = 𝜔 + ∑ 𝛼𝑖 𝑒𝑡−1 + ∑ 𝛽𝑖 ℎ𝑡−1
𝑖=1 𝑖=1 (3.31)
𝑝 ≥ 0, 𝑞 > 0, 𝜔0 > 0, 𝛼1 > 0, 𝛽1 > 0

The above is the “Plain Vanilla” GARCH(p,q), where p and q are the number

of lagged h and e2 terms, respectively. It can be derived by transforming equation 3.30

using a geometric lag structure:

2 2
ℎ𝑡 = 𝛼0 + 𝛼1 𝑒𝑡−1 + 𝛽1 𝛼1 𝑒𝑡−2 + 𝛽12 𝛼1 𝑒𝑡−3
2
… (3.32)

equation 3.32 lagged one period,

2
ℎ𝑡−1 = 𝛼0 + 𝛼1 𝑒𝑡−2 2
+ 𝛽1 𝛼1 𝑒𝑡−3 + 𝛽13 𝛼1 𝑒𝑡−4
2
… (3.33)

by inserting in equation 3.33 into 3.32 GARCH(1,1)

2
ℎ𝑡 = 𝜔0 + 𝛼1 𝑒𝑡−2 + 𝛽1 ℎ𝑡−1 ,
(3.34)
𝜔0 > 0, 0 ≤ 𝛼1 < 1, 0 ≤ 𝛽1 < 1
GARCH-in-mean model is an extension that allows using volatility to explain,

in our case, exchange rates. Hence the mean equation in 3.34 includes volatility.

𝑟𝑡 = µ0 + 𝛾ℎ𝑡 + 𝑒𝑡
2 (3.35)
ℎ𝑡 = 𝜔 + 𝛼1 𝑒𝑡−1 + 𝛽1 ℎ𝑡−1 ,

It is of our interest to test the impact of conditional volatility of exchange rates

on exports. To this end the following extension of the GARCH model are estimated.

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