Discovering the Drivers of Market Volatility: Asset Allocation Applications

69 Pages Posted: 22 Jun 2021 Last revised: 30 Jul 2021

See all articles by Hoon Cho

Hoon Cho

Korea Advanced Institute of Science and Technology (KAIST)

Dohyun Chun

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Doojin Ryu

Sungkyunkwan University

Date Written: June 14, 2021

Abstract

This study investigates the economic and financial drivers of volatility changes and integrates them into stock market volatility forecasting. We first collect a diverse set of predictor variables and analyze them within a unified framework. We discover that only a small number of variables contain significant predictive information, and that the Chinese stock market return significantly predicts U.S. stock market volatility. Using the HAR-LASSO procedure, we integrate the drivers’ predictive information and forecast short-term, medium-term, and long-term market volatilities. Through various volatility timing strategies, we verify that HAR-LASSO-based portfolios lead to outstanding investment performance, regardless of the strategies and forecasting horizons. These results not only economically justify our procedure, but also provide meaningful financial implications of accurate volatility forecasting.

Keywords: asset allocation, HAR model, LASSO, volatility forecasting, realized volatility

JEL Classification: C52, C58, G15

Suggested Citation

Cho, Hoon and Chun, Dohyun and Ryu, Doojin, Discovering the Drivers of Market Volatility: Asset Allocation Applications (June 14, 2021). Available at SSRN: https://ssrn.com/abstract=3866400 or http://dx.doi.org/10.2139/ssrn.3866400

Hoon Cho

Korea Advanced Institute of Science and Technology (KAIST) ( email )

87 Hoegiro
Dongdaemun-Gu
Seoul 130-722
Korea
+82-2-958-3413 (Phone)

Dohyun Chun

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

85 Hoegiro Dongdaemun-Gu
Seoul 02455
Korea, Republic of (South Korea)

Doojin Ryu (Contact Author)

Sungkyunkwan University ( email )

53 Myeongnyun-dong 3-ga Jongno-ju
Guro-gu
Seoul, 110-745
Korea, Republic of (South Korea)

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