Modeling and Forecasting Exchange Rate Volatility in Time-Frequency Domain

33 Pages Posted: 31 May 2012 Last revised: 4 Feb 2015

See all articles by Jozef Barunik

Jozef Barunik

Charles University in Prague - Department of Economics; Institute of Information Theory and Automation, Prague

Tomas Krehlik

Charles University in Prague; Czech Academy of Sciences

Lukas Vacha

Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic; Charles University in Prague - Department of Economics

Date Written: February 3, 2015

Abstract

This paper proposes an enhanced approach to modeling and forecasting volatility using high frequency data. Using a forecasting model based on Realized GARCH with multiple time-frequency decomposed realized volatility measures, we study the influence of different timescales on volatility forecasts. The decomposition of volatility into several timescales approximates the behaviour of traders at corresponding investment horizons. The proposed methodology is moreover able to account for impact of jumps due to a recently proposed jump wavelet two scale realized volatility estimator. We propose a realized Jump-GARCH models estimated in two versions using maximum likelihood as well as observation-driven estimation framework of generalized autoregressive score. We compare forecasts using several popular realized volatility measures on foreign exchange rate futures data covering the recent financial crisis. Our results indicate that disentangling jump variation from the integrated variation is important for forecasting performance. An interesting insight into the volatility process is also provided by its multiscale decomposition. We find that most of the information for future volatility comes from high frequency part of the spectra representing very short investment horizons. Our newly proposed models outperform statistically the popular as well conventional models in both one-day and multi-period-ahead forecasting.

Keywords: wavelet decomposition, jumps, volatility forecasting, Realized GARCH

JEL Classification: C14, C53, G17

Suggested Citation

Barunik, Jozef and Krehlik, Tomas and Vacha, Lukas, Modeling and Forecasting Exchange Rate Volatility in Time-Frequency Domain (February 3, 2015). Available at SSRN: https://ssrn.com/abstract=2035353 or http://dx.doi.org/10.2139/ssrn.2035353

Jozef Barunik (Contact Author)

Charles University in Prague - Department of Economics ( email )

Opletalova 26
Prague 1, 110 00
Czech Republic

HOME PAGE: http://ies.fsv.cuni.cz/en/staff/barunik

Institute of Information Theory and Automation, Prague ( email )

Pod vodarenskou vezi 4
CZ-18208 Praha 8
Czech Republic

HOME PAGE: http://staff.utia.cas.cz/barunik/home.htm

Tomas Krehlik

Charles University in Prague ( email )

Praha 1
Czech Republic

Czech Academy of Sciences ( email )

Narodni 3, 111 42
Praha 1, 117 20
Czech Republic

Lukas Vacha

Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic ( email )

Pod vodarenskou vezi 4
Praha, CZ-18208
Czech Republic

Charles University in Prague - Department of Economics ( email )

Opletalova 26
Prague, 11000
Czech Republic

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