The Limits to Volatility Predictability: Quantifying Forecast Accuracy Across Horizons

34 Pages Posted: 31 Aug 2018

See all articles by Valeriy Zakamulin

Valeriy Zakamulin

University of Agder - School of Business and Law

Xingyi Li

School of Business and Law, University of Agder

Date Written: June 19, 2018

Abstract

Volatility forecasting is crucial for portfolio management, risk management, and pricing of derivative securities. Still, little is known about how far ahead one can forecast volatility. First, in this paper we introduce the notions of the spot and forward predicted volatilities and propose to describe the term structure of volatility predictability by the spot and forward forecast accuracy curves. Then, by employing a few popular time-series volatility models, we perform a comprehensive empirical study on the horizon of volatility predictability. Our results suggest that, whereas the spot volatility can be predicted over horizons that extend to 35 weeks, the horizon of the forward volatility predictability is rather short and limited to approximately 7.5 weeks. Finally, we suggest a plausible explanation for why standard models fail to provide sensible longer-horizon volatility forecasts.

Keywords: spot volatility, forward volatility, volatility forecasting, forecast accuracy, term structure, out-of-sample forecasting, model comparison, meta-analysis

JEL Classification: C22, C53, C58, G17

Suggested Citation

Zakamulin, Valeriy and Li, Xingyi, The Limits to Volatility Predictability: Quantifying Forecast Accuracy Across Horizons (June 19, 2018). Available at SSRN: https://ssrn.com/abstract=3237746 or http://dx.doi.org/10.2139/ssrn.3237746

Valeriy Zakamulin (Contact Author)

University of Agder - School of Business and Law ( email )

Service Box 422
Kristiansand, N-4604
Norway
+47 38141039 (Phone)

HOME PAGE: http://vzakamulin.weebly.com/

Xingyi Li

School of Business and Law, University of Agder ( email )

Serviceboks 422
N-4604 Kristiansand, VEST AGDER 4604
Norway
38141338 (Phone)

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