Forecasting Volatility with Time-Varying Leverage and Volatility of Volatility Effects

26 Pages Posted: 19 Dec 2018

See all articles by Leopoldo Catania

Leopoldo Catania

Aarhus University - School of Business and Social Sciences; Aarhus University - CREATES

Tommaso Proietti

University of Rome II - Department of Economics and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: November 30, 2018

Abstract

The prediction of volatility is of primary importance for business applications in risk management, asset allocation and pricing of derivative instruments. This paper proposes a novel measurement model which takes into consideration the possibly time-varying interaction of realized volatility and asset returns, according to a bivariate model aiming at capturing the main stylised facts: (i) the long memory of the volatility process, (ii) the heavy-tailedness of the returns distribution, and (iii) the negative dependence of volatility and daily market returns. We assess the relevance of "volatility in volatility" and "time-varying leverage" effects in the out-of-sample forecasting performance of the model, and evaluate the density forecasts of the future level of market volatility. The empirical results illustrate that our specication can outperform the benchmark HAR-RV, both in terms of point and density forecasts.

Keywords: realized volatility, forecasting, leverage effect, volatility in volatility

Suggested Citation

Catania, Leopoldo and Proietti, Tommaso, Forecasting Volatility with Time-Varying Leverage and Volatility of Volatility Effects (November 30, 2018). Available at SSRN: https://ssrn.com/abstract=3293904 or http://dx.doi.org/10.2139/ssrn.3293904

Leopoldo Catania (Contact Author)

Aarhus University - School of Business and Social Sciences ( email )

Fuglesangs Allé 4
Aarhus V, DK-8210
Denmark
+4587165536 (Phone)

HOME PAGE: http://pure.au.dk/portal/en/leopoldo.catania@econ.au.dk

Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Tommaso Proietti

University of Rome II - Department of Economics and Finance ( email )

Via Columbia, 2
Rome, 00133
Italy

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