On Heteroskedasticity and Regimes in Volatility Forecasting

22 Pages Posted: 19 Sep 2017

See all articles by Fabrizio Cipollini

Fabrizio Cipollini

Universita di Firenze, DiSIA (Dipartimento di Statistica, Informatica, Applicazioni)

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: September 14, 2017

Abstract

In this paper we discuss some deep implications of the recent paper by Bollerslev et al. (2016) (BPQ). In BPQ the volatility dynamics modeled as a HAR is augmented by a term involving quarticity in order to correct measurement errors in realized variance. We show that the model is observationally equivalent to another where a quadratic term in realized variance accounts for a faster mean reversion when volatility is high. We argue that heteroskedasticity (volatility of volatility) and a time-varying mean seem to play a role of higher order of importance than measurement errors. In fact, the quarticity/quadratic terms disappear within an AMEM, and more so when a Markov Switching dynamics is considered. Some simulation results show that when the DGP is a (MS-)AMEM, such terms turn out spuriously significant in a HAR. Forecast performance of the (MS-)AMEM is superior to the augmented HARs.

Keywords: Realized Volatility, Forecasting, Measurement Errors, HAR, AMEM, Markov Switching, Volatility of Volatility

JEL Classification: C22, C51, C53, C58

Suggested Citation

Cipollini, Fabrizio and Gallo, Giampiero M. and Otranto, Edoardo, On Heteroskedasticity and Regimes in Volatility Forecasting (September 14, 2017). Available at SSRN: https://ssrn.com/abstract=3037550 or http://dx.doi.org/10.2139/ssrn.3037550

Fabrizio Cipollini

Universita di Firenze, DiSIA (Dipartimento di Statistica, Informatica, Applicazioni) ( email )

Viale Morgagni, 59
Florence, Florence 50134
Italy
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+39 055 4223560 (Fax)

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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