Forecasting Financial Volatility with Combined QML and LAD-ARCH Estimators of the GARCH Model

19 Pages Posted: 17 Sep 2013

See all articles by Liam Cheung

Liam Cheung

McGill University

John W. Galbraith

McGill University - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Date Written: July 16, 2013

Abstract

GARCH models and their variants are usually estimated using quasi-Maximum Likelihood (QML). Recent work has shown that by using estimates of quadratic variation, for example from the daily realized volatility, it is possible to estimate these models in a different way which incorporates the additional information. Theory suggests that as the precision of estimates of daily quadratic variation improves, such estimates (via LAD- ARCH approximation) should come to equal and eventually dominate the QML estimators. The present paper investigates this using a five-year sample of data on returns from all 466 S&P 500 stocks which were present in the index continuously throughout the period. The results suggest that LAD-ARCH estimates, using realized volatility on five-minute returns over the trading day, yield measures of 1-step forecast accuracy comparable or slightly superior to those obtained from QML estimates. Combining the two estimators, either by equal weighting or weighting based on cross-validation, appears to produce a clear improvement in forecast accuracy relative to either of the two different forecasting methods alone.

Keywords: QML and LAD-ARCH estimators, GARCH models

Suggested Citation

Cheung, Liam and Galbraith, John W., Forecasting Financial Volatility with Combined QML and LAD-ARCH Estimators of the GARCH Model (July 16, 2013). CIRANO - Scientific Publications 2013s-19, Available at SSRN: https://ssrn.com/abstract=2326647 or http://dx.doi.org/10.2139/ssrn.2326647

Liam Cheung

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

John W. Galbraith (Contact Author)

McGill University - Department of Economics ( email )

855 Sherbrooke St. W
Montreal, Quebec H3A 2T7
Canada

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

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