Varying coefficient GARCH versus local constant volatility modeling. Comparison of the predictive power

GARCH models are widely used in financial econometrics. However, we show by mean of a simple simulation example that the GARCH approach may lead to a serious model misspecification if the assumption of stationarity is violated. In particular, the well known integrated GARCH effect can be explained by nonstationarity of the time series. We then introduce a more general class of GARCH models with time varying coefficients and present an adaptive procedure which can estimate the GARCH coefficients as a function of time. We also discuss a simpler semiparametric model in which the beta-parameter is fixed...