Modeling and Forecasting Realized Volatility

47 Pages Posted: 9 Mar 2001 Last revised: 26 Oct 2022

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)

Francis X. Diebold

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

Paul Labys

Charles River Associates (CRA) - Utah Office

Multiple version iconThere are 2 versions of this paper

Date Written: March 2001

Abstract

This paper provides a general framework for integration of high-frequency intraday data into the measurement forecasting of daily and lower frequency volatility and return distributions. Most procedures for modeling and forecasting financial asset return volatilities, correlations, and distributions rely on restrictive and complicated parametric multivariate ARCH or stochastic volatility models, which often perform poorly at intraday frequencies. Use of realized volatility constructed from high-frequency intraday returns, in contrast, permits the use of traditional time series procedures for modeling and forecasting. Building on the theory of continuous-time arbitrage-free price processes and the theory of quadratic variation, we formally develop the links between the conditional covariancematrix and the concept of realized volatility. Next, using continuously recorded observations for the Deutschemark Dollar and Yen / Dollar spot exchange rates covering more than a decade, we find that forecasts from a simple long-memory Gaussian vector autoregression for the logarithmic daily realized volatilities perform admirably compared to popular daily ARCH and related models. Moreover, the vector autoregressive volatility forecast, coupled with a parametric lognormal-normal mixture distribution implied by the theoretically and empirically grounded assumption of normally distributed standardized returns, gives rise to well-calibrated density forecasts of future returns, and correspondingly accurate quantile estimates. Our results hold promise for practical modeling and forecasting of the large covariance matrices relevant in asset pricing, asset allocation and financial risk management applications.

Suggested Citation

Andersen, Torben G. and Bollerslev, Tim and Diebold, Francis X. and Labys, Paul, Modeling and Forecasting Realized Volatility (March 2001). NBER Working Paper No. w8160, Available at SSRN: https://ssrn.com/abstract=262720

Torben G. Andersen (Contact Author)

Northwestern University - Kellogg School of Management ( email )

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National Bureau of Economic Research (NBER) ( 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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National Bureau of Economic Research (NBER)

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Francis X. Diebold

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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215-898-1507 (Phone)
215-573-4217 (Fax)

HOME PAGE: http://www.ssc.upenn.edu/~fdiebold/

National Bureau of Economic Research (NBER)

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United States

Paul Labys

Charles River Associates (CRA) - Utah Office ( email )

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Salt Lake City, UT 84101
United States
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801.536.1501 (Fax)

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