# Fitting a non-stationary GARCH model

I'm very new to financial time series. I have a dataset containing the daily simple returns of the Dow Jones Industrial Average and I want to model a (univariate) GARCH model for the daily logreturns. I'm working in R.

First I transform the simple into log returns using DJIA = log(DJIA_simple + 1). The Ljung-Box test says that the time series is not stationary, and when I take first differences the sample ACF and PACF are both 0 for all non-zero lags.

I want to use the rugarch packages, but I don't know how to proceed. I think that I have two options, but I don't know the 'correct' one:

1. First difference the data and call the rugarch::ugarchspec function with variance.model = list(model = "GARCH", garchOrder = c(1,1))
2. Don't difference the data and call the rugarch::ugarchspec function with variance.model = list(model ="iGARCH", garchOrder = c(1,1)).

(After doing either of this, I run garch_djia <- rugarch::ugarchfit(spec = spec, data = DJIA, solver.control = list(trace=0)).)

Note that I am only interested in a GARCH model; I do not care that much about an ARMA or ARIMA model for the mean. (But I don't think I need one since after differencing the time series looks like white noise to me, with mean 0.)

I am familiar with all the theory regarding time series, just not with actually modelling one in practice. Any help would be greatly appreciated.

EDIT: When I run stats::Box.test(garch_djia@fit$residuals, lag = 4, type = "Ljung-Box", fitdf = 2), I get a p-value of 0.0001049 (similar results for other values of fitdf, but I believe that for GARCH(p, q) models the value of fitdf needs to be the sum of p and q. Additionally, running eps_t = (garch_djia@fit$residuals)/(garch_djia@fit\$sigma) results in a variable with mean -0.04487383 and variance 1.135489. Since we are modelling $$a_t = \sigma_t \epsilon_t$$ (with $$a_t$$ the residuals and $$\epsilon_t \sim (0, 1)$$), does this mean the model is 'good' because the mean and variance of eps_t are relatively close to 0 and 1?

• I'm familiar with R but not rugarch. My not terribly useful advice would be to read the vignette on the rugarch package which should be on cran. The issues you address will most likely be explain in there. – mark leeds Mar 10 at 16:01
• Welcome to quant SE, the log returns should be stationary and the Ljung-Box test is not a stationary test (ex of stationary tests are Dickey Fuller Test or Phillips Perron Test). You don't need to difference the returns since they are stationary. So the returns should be used as data for both garch or igarch modeling. – Malick Mar 11 at 9:43