Assessing the Performance of a Prediction Error Criterion Model Selection Algorithm in the Context of ARCH Models

Applied Financial Economics, Vol. 17, pp. 149-171, 2007

23 Pages Posted: 11 Nov 2007 Last revised: 1 Feb 2009

See all articles by Stavros Antonios Degiannakis

Stavros Antonios Degiannakis

Department of Economic and Regional Development, Panteion University of Political and Social Sciences

Evdokia Xekalaki

Athens University of Economics and Business

Abstract

A number of ARCH models are considered in the framework of evaluating the performance of a method for model selection based on a standardized prediction error criterion (SPEC). According to this method, the ARCH model with the lowest sum of squared standardized forecasting errors is selected for predicting future volatility. A number of statistical criteria, that measure the distance between predicted and inter-day realized volatility, are used to examine the performance of a model to predict future volatility, for forecasting horizons ranging from one day to 100 days ahead. The results reveal that the SPEC model selection procedure has a satisfactory performance in picking that model that generates 'better' volatility predictions. A comparison of the SPEC algorithm with a set of other model evaluation criteria yields similar findings. It appears, therefore, that it can be regarded as a tool in guiding the choice of the appropriate model for predicting future volatility, with applications in evaluating portfolios, managing financial risk and creating speculative strategies with options.

Suggested Citation

Degiannakis, Stavros Antonios and Xekalaki, Evdokia, Assessing the Performance of a Prediction Error Criterion Model Selection Algorithm in the Context of ARCH Models. Applied Financial Economics, Vol. 17, pp. 149-171, 2007, Available at SSRN: https://ssrn.com/abstract=1028732

Stavros Antonios Degiannakis

Department of Economic and Regional Development, Panteion University of Political and Social Sciences ( email )

136 Sygrou
Athens
Greece

Evdokia Xekalaki (Contact Author)

Athens University of Economics and Business ( email )

76 Patission Street
GR-10434 Athens
Greece

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