On the Economic Evaluation of Volatility Forecasts

CREATES Research Paper 2009-56

24 Pages Posted: 28 Nov 2009

See all articles by Valeri Voev

Valeri Voev

Aarhus University - CREATES

Date Written: November 25, 2009

Abstract

We analyze the applicability of economic criteria for volatility forecast evaluation based on unconditional measures of portfolio performance. The main theoretical finding is that such unconditional measures generally fail to rank conditional forecasts correctly due to the presence of a bias term driven by the variability of the conditional mean and portfolio weights. Simulations and a small empirical study suggest that the bias can be empirically substantial and lead to distortions in forecast evaluation. An important implication is that forecasting superiority of models using high frequency data is likely to be understated if unconditional criteria are used.

Keywords: Forecast evaluation, Volatility forecasting, Portfolio optimization, Mean-variance analysis

JEL Classification: C32, C53, G11

Suggested Citation

Voev, Valeri, On the Economic Evaluation of Volatility Forecasts (November 25, 2009). CREATES Research Paper 2009-56, Available at SSRN: https://ssrn.com/abstract=1513264 or http://dx.doi.org/10.2139/ssrn.1513264

Valeri Voev (Contact Author)

Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

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