Forecasting Realized Volatility with Changes of Regimes

40 Pages Posted: 6 Feb 2014

See all articles by Giampiero M. Gallo

Giampiero M. Gallo

Corte dei Conti - Italian Court of Audits; University of Bologna - Rimini Center for Economic Analysis (RCEA); Universita' di Firenze - Dipartimento di Statistica, Informatica, Applicazioni "G.Parenti"

Edoardo Otranto

University of Messina; Universita di Cagliari - Centre for North South Economic Research (CRENOS)

Date Written: February 4, 2014

Abstract

Realized volatility of financial time series generally shows a slow-moving average level from the early 2000s to recent times, with alternating periods of turmoil and quiet. Modeling such a pattern has been variously tackled in the literature with solutions spanning from long-memory, Markov switching and spline interpolation. In this paper, we explore the extension of Multiplicative Error Models to include a Markovian dynamics (MS-MEM). Such a model is able to capture some sudden changes in volatility following an abrupt crisis and to accommodate different dynamic responses within each regime. The model is applied to the realized volatility of the S&P500 index: next to an interesting interpretation of the regimes in terms of market events, the MS-MEM has better in-sample fitting capability and achieves good out-of-sample forecasting performances relative to alternative specifications.

Keywords: MEM, regime switching, realized volatility, volatility persistence, volatility forecasting

JEL Classification: C22, C24, C58

Suggested Citation

Gallo, Giampiero M. and Otranto, Edoardo, Forecasting Realized Volatility with Changes of Regimes (February 4, 2014). Available at SSRN: https://ssrn.com/abstract=2390780 or http://dx.doi.org/10.2139/ssrn.2390780

Giampiero M. Gallo (Contact Author)

Corte dei Conti - Italian Court of Audits ( email )

viale Mazzini
Roma, Roma 00195
Italy

University of Bologna - Rimini Center for Economic Analysis (RCEA) ( email )

Via Patara, 3
Rimini (RN), RN 47900
Italy

Universita' di Firenze - Dipartimento di Statistica, Informatica, Applicazioni "G.Parenti" ( email )

Viale G.B. Morgagni, 59
Florence, 50134
Italy
0039 055 2751 591 (Phone)
0039 055 4223560 (Fax)

HOME PAGE: http://www.disia.unifi.it/gallog

Edoardo Otranto

University of Messina ( email )

Piazza Pugliatti, 1
Messina, 98122
Italy

Universita di Cagliari - Centre for North South Economic Research (CRENOS) ( email )

V. S. Ignazio 78
Cagliari, 09124
Italy

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