A Dynamic Component Model for Forecasting High-Dimensional Realized Covariance Matrices
Econometrics and Statistics, 1, 40-61, 2017
24 Pages Posted: 9 May 2017
Date Written: November 3, 2016
The Multiplicative MIDAS Realized DCC (MMReDCC) model simultaneously accounts for short and long term dynamics in the conditional (co)volatilities of asset returns, in line with the empirical evidence suggesting that their level is changing over time as a function of economic conditions.
Herein the applicability of the model is improved along two directions.
First, by proposing an algorithm that relies on the maximization of an iteratively re-computed moment-based profile likelihood function and keeps estimation feasible in large dimensions by mitigating the incidental parameter problem.
Second, by illustrating a conditional bootstrap procedure to generate multi-step ahead predictions from the model. In an empirical application on a dataset of forty-six equities, the MMReDCC model is found to statistically outperform the selected benchmarks in terms of in-sample fit as well as in terms of out-of-sample covariance predictions. The latter are mostly significant in periods of high market volatility.
Keywords: Realized covariance, dynamic component models, multi-step forecasting, iterative algorithm
JEL Classification: C13, C32, C58
Suggested Citation: Suggested Citation