3.2.2.

1 VAR GARCH-in mean

There are many ways to extend the GARCH model for a multivariate case.15

However, we confront with a major problem, the curse of dimensionality. There is a

family of GARCH models introduced by Bollerslev (1990) called constant correlation

models and is used to test hypothesis 2. Its main feature is imposing the restriction of

time-invariant correlation coefficients (ρ21,t= ρ21) between 𝑒1,𝑡 and 𝑒2,𝑡 to keep the

number of volatility equations low.

Mean equations:

𝑟1,𝑡 = 𝛾10 + 𝛾11,𝑡−1 𝑟1,𝑡−1 + ⋯ + 𝛾11,𝑡−𝑘 𝑟1,𝑡−𝑘

+ 𝛾12,𝑡−1 𝑟2,𝑡−1 + ⋯ + 𝛾12,𝑡−𝑘 𝑟2,𝑡−𝑘
+ 𝛾13 ℎ1,𝑡 + 𝛾14 ℎ2,𝑡 + 𝑒1,𝑡
(3.36)
𝑟2,𝑡 = 𝛾20 + 𝛾21,𝑡−1 𝑟1,𝑡−1 + ⋯ + 𝛾21,𝑡−𝑘 𝑟1,𝑡−𝑘
+ 𝛾22,𝑡−1 𝑟2,𝑡−1 + ⋯ + 𝛾22,𝑡−𝑘 𝑟2,𝑡−𝑘
+ 𝛾23 ℎ1,𝑡 + 𝛾24 ℎ2,𝑡 + 𝑒2,𝑡

Volatility equations:

2
ℎ1,𝑡 = 𝜔1 + 𝛼11 𝑒1,𝑡−1 + 𝛽11 ℎ1,𝑡−1 .
2
ℎ2,𝑡 = 𝜔2 + 𝛼22 𝑒2,𝑡−1 + 𝛽22 ℎ2,𝑡−1 . (3.37)

Notice that in equation 3.37, cross parameters α12, α21, β12, and β21 are

missing. That is because by imposing the time-invariant restriction, these parameters

become equal to zero thereby reducing the number of parameters to be estimated. Yet

we sacrifice the original export demand equation and limit the number of variables to

only two to avoid over-parameterization. The way we proceed is by estimating

15
Tsay (2005)

42