Journal of Economic Perspectives—Volume 15, Number 4 —Fall 2001—Pages 157–168

GARCH 101: The Useof ARCH/GARCH Models in Applied Econometrics
Robert Engle

T

he great workhorse of appliedeconometrics is the least squares model. This is a natural choice, because applied econometricians aretypically called upon to determine how much one variable will change in response to a change insome other variable. Increasingly however, econometricians are being asked to forecast and analyze thesize of the errors of the model. In this case, the questions are about volatility, and the standardtools have become the ARCH/ GARCH models. The basic version of the least squares model assumes thatthe expected value of all error terms, when squared, is the same at any given point. This assumptionis called homoskedasticity, and it is this assumption that is the focus of ARCH/ GARCH models. Datain which the variances of the error terms are not equal, in which the error terms may reasonably be [continua]

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