A No Arbitrage Fractional Cointegration Analysis of the Range Based Volatility

CREATES Research Paper No. 2009-31

36 Pages Posted: 16 Jul 2009 Last revised: 22 Sep 2010

See all articles by Eduardo Rossi

Eduardo Rossi

Department of Economics and Management

Paolo Santucci de Magistris

Aarhus University - CREATES

Date Written: July 16, 2009

Abstract

The no arbitrage relation between futures and spot prices implies an analogous relation between futures and spot volatilities as measured by daily range. Long memory features of the range-based volatility estimators of the two series are analyzed, and their joint dynamics are modeled via a fractional vector error correction model (FVECM), in order to explicitly consider the no arbitrage constraints. We introduce a two-step estimation procedure for the FVECM parameters and we show the properties by a Monte Carlo simulation. The out-of-sample forecasting superiority of FVECM, with respect to competing models, is documented. The results highlight the importance of giving fully account of long-run equilibria in volatilities in order to obtain better forecasts.

Keywords: Range-based volatility estimator, Long memory, Fractional cointegration, Fractional VECM, Stock Index Futures

JEL Classification: C32, C13, G13

Suggested Citation

Rossi, Eduardo and Santucci de Magistris, Paolo, A No Arbitrage Fractional Cointegration Analysis of the Range Based Volatility (July 16, 2009). CREATES Research Paper No. 2009-31, Available at SSRN: https://ssrn.com/abstract=1434792 or http://dx.doi.org/10.2139/ssrn.1434792

Eduardo Rossi (Contact Author)

Department of Economics and Management ( email )

Via San Felice 5
27100 Pavia
Italy
++ (Phone)

Paolo Santucci de Magistris

Aarhus University - CREATES ( email )

Department of Economics and Business Economics
Fuglesangs Allè 4
Aarhus V, 8210
Denmark

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
148
Abstract Views
1,040
rank
270,222
PlumX Metrics