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

29 Pages Posted: 7 Feb 2019

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: February 6, 2019

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 speci fication 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 (February 6, 2019). CEIS Working Paper No. 450. Available at SSRN: https://ssrn.com/abstract=3330048 or http://dx.doi.org/10.2139/ssrn.3330048

Leopoldo Catania

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 (Contact Author)

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

Via Columbia, 2
Rome, 00133
Italy

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