Answering the Critics: Yes, Arch Models Do Provide Good Volatility Forecasts

37 Pages Posted: 14 Jul 2000 Last revised: 21 Apr 2008

See all articles by Torben G. Andersen

Torben G. Andersen

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Aarhus University - CREATES

Tim Bollerslev

Duke University - Finance; Duke University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: April 1997

Abstract

Volatility permeates modern financial theories and decision making processes. As such, accurate measures and good forecasts of future volatility are critical for the implementation and evaluation of asset pricing theories. In response to this, a voluminous literature has emerged for modeling the temporal dependencies in financial market volatility at the daily and lower frequencies using ARCH and stochastic volatility type models. Most of these studies find highly significant in-sample parameter estimates and pronounced intertemporal volatility persistence. Meanwhile, when judged by standard forecast evaluation criteria, based on the squared or absolute returns over daily or longer forecast horizons, ARCH models provide seemingly poor volatility forecasts. The present paper demonstrates that ARCH models, contrary to the above contention, produce strikingly accurate interdaily forecasts for the latent volatility factor that is relevant for most financial applications.

Suggested Citation

Andersen, Torben G. and Bollerslev, Tim, Answering the Critics: Yes, Arch Models Do Provide Good Volatility Forecasts (April 1997). NBER Working Paper No. w6023. Available at SSRN: https://ssrn.com/abstract=226433

Torben G. Andersen (Contact Author)

Northwestern University - Kellogg School of Management ( email )

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Aarhus University - CREATES ( email )

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Tim Bollerslev

Duke University - Finance ( email )

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Duke University - Department of Economics

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