A GARCH Model with Artificial Neural Networks

Abstract

In this paper, we incorporate a GARCH model into an artificial neural network (ANN) for financial volatility modeling and estimate the parameters in Tensorflow. Our goal was to better predict stock volatility. We evaluate the performance of the models using the mean absolute errors of powers of the out-of-sample returns between 2 March 2018 and 28 February 2020. Our results show that our modeling procedure with an ANN can outperform the standard GARCH(1,1) model with standardized Student’s t distribution. Our variable importance analysis shows that Net Debt/EBITA is among the six most important predictor variables in all of the neural network models we have examined. The main contribution of this paper is that we propose a Long Short-Term Memory (LSTM) model with a GARCH framework because LSTM can systematically take into consideration potential nonlinearity in volatility structure at different time points. One of the advantages of our research is that the proposed models are easy to implement because our proposed models can be run in Tensorflow, a Python package that enables fast and automatic optimization. Another advantage is that the proposed models enable variable importance analysis.

Keywords

• deep learning networks
• financial returns
• LSTM
• Tensorflow
• volatility modeling