Excel Models
Using GARCH to Forecast Volatility
๐ฏ GARCH is not just a descriptive model โ its purpose is to forecast the volatility of future returns on invested capital.
In previous posts, we:
- Explained the GARCH model
- Estimated its parameters using the Maximum Likelihood Method (MLE)
- Validated the model by removing volatility clustering
Now we answer the key question:
How do we use the model once we are confident it works properly?
๐ง Forecasting Mechanism
The original model is defined as:
However, when forecasting, future shocks are unknown.
Therefore, we replace them with their expected values, which gives:
This means that volatility evolves according to a simple logic:
๐ its current level gradually moves toward a long-term level โ a kind of gravitational equilibrium
Where:
๐ What This Looks Like in Excel

- We start from the current variance (ฯโยฒ)
- We forecast forward (t = 1โฆ30)
- We convert variance into volatility
The result:
๐ a smooth curve that converges toward equilibrium

๐ What Determines the Shape of the Curve
Two key factors:
- Persistence (ฮฑ + ฮฒ)
High โ slow adjustment
Low โ fast adjustment - Mean Reversion
Volatility does not remain at extreme levels โ it gradually returns to equilibrium
๐ Excel: Volatility Forecast โ GARCH
Adapted from:
Options, Futures & Other Derivatives, John C. Hull