On the Robustness of the Principal Volatility Components
37 Pages Posted: 19 Mar 2018 Last revised: 12 Dec 2018
Date Written: March 19, 2018
In this paper, we analyse the recent principal volatility components analysis procedure. The procedure overcomes several difficulties in modelling and forecasting the conditional covariance matrix in large dimensions arising from the curse of dimensionality. We show that outliers have a devastating effect on the construction of the principal volatility components and on the forecast of the conditional covariance matrix and consequently in economic and financial applications based on this forecast. We propose a robust procedure and analyse its finite sample properties by means of Monte Carlo experiments and also illustrate it using empirical data. The robust procedure outperforms the classical method in simulated and empirical data.
Keywords: Conditional Covariance Matrix, Constant Volatility, Curse of Dimensionality, Jumps, Outliers, Principal Components
JEL Classification: C13, C51, C53, C55, G17
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