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A Comprehensive Look at Financial Volatility Prediction by Economic Variables

45 Pages Posted: 10 Jan 2011 Last revised: 6 Mar 2012

Charlotte Christiansen

University of Aarhus - CREATES

Maik Schmeling

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department

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Date Written: January 8, 2011

Abstract

We investigate if asset return volatility is predictable by macroeconomic and financial variables and shed light on the economic drivers of financial volatility. Our approach is distinct due to its comprehensiveness: First, we employ a data-rich forecast methodology to handle a large set of potential predictors in a Bayesian Model Averaging approach, and, second, we take a look at multiple asset classes (equities, foreign exchange, bonds, and commodities) over long time spans. We find that proxies for credit risk and funding (il)liquidity consistently show up as common predictors of volatility across asset classes. Variables capturing time-varying risk premia also perform well as predictors of volatility. While forecasts by macro-finance augmented models also achieve forecasting gains out-of-sample relative to autoregressive benchmarks, the performance varies across asset classes and over time.

Keywords: Realized volatility, Forecasting, Data-rich modeling, Bayesian model averaging, Model uncertainty

JEL Classification: G12, G15, G17, C53

Suggested Citation

Christiansen, Charlotte and Schmeling, Maik and Schrimpf, Andreas, A Comprehensive Look at Financial Volatility Prediction by Economic Variables (January 8, 2011). Available at SSRN: https://ssrn.com/abstract=1737433 or http://dx.doi.org/10.2139/ssrn.1737433

Charlotte Christiansen (Contact Author)

University of Aarhus - CREATES ( email )

Fuglesangs Alle 4
Aarhus V, DK 8210
Denmark

Maik Schmeling

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Andreas Schrimpf

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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