(a) Distinguish between the terms ‘conditional variance’ and

‘unconditional variance’. Which of the two is more likely to be relevant for producing:

i. 1-step-ahead volatility forecasts ii. 20-step-ahead volatility forecasts.

(a) If ut follows a GARCH(1,1) process, what would be the likely result if a regression of the form (8.110) were estimated using OLS and assuming a constant conditional variance?

(b) Compare and contrast the following models for volatility, noting their strengths and weaknesses:

i. Historical volatility ii. EWMA iii. GARCH(1,1)

iv. Implied volatility.

AppendixLO1