Choosing the Best Volatility Models: The Model Confidence Set Approach

Brown University Economics Working Paper No. 03-05; FRB of Atlanta Working Paper No. 2003-28

26 Pages Posted: 22 May 2003

See all articles by Peter Reinhard Hansen

Peter Reinhard Hansen

University of North Carolina (UNC) at Chapel Hill - Department of Economics; Copenhagen Business School, Finance; Aarhus University - CREATES

Asger Lunde

Aarhus University - School of Business and Social Sciences; CREATES

James M. Nason

North Carolina State University - Department of Economics

Date Written: October 2003

Abstract

This paper applies the model confidence sets (MCS) procedure to a set of volatility models. A MSC is analogous to a confidence interval of parameter in the sense that the former contains the best forecasting model with a certain probability. The key to the MCS is that it acknowledges the limitations of the information in the data. The empirical exercise is based on fifty-five volatility models, and the MCS includes about a third of these when evaluated by mean square error, whereas the MCS contains only a VGARCH model when mean absolute deviation criterion is used. We conduct a simulation study that shows the MCS captures the superior models across a range of significance levels. When we benchmark the MCS relative to a Bonferroni bound, this bound delivers inferior performance.

Keywords: Forecasting, Model Selection, Multiple Comparisons, Data Mining

JEL Classification: C12, C19, C44, C52, C53

Suggested Citation

Hansen, Peter Reinhard and Lunde, Asger and Nason, James M., Choosing the Best Volatility Models: The Model Confidence Set Approach (October 2003). Brown University Economics Working Paper No. 03-05; FRB of Atlanta Working Paper No. 2003-28, Available at SSRN: https://ssrn.com/abstract=399060 or http://dx.doi.org/10.2139/ssrn.399060

Peter Reinhard Hansen (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Chapel Hill, NC 27599
United States

HOME PAGE: http://https://sites.google.com/site/peterreinhardhansen/

Copenhagen Business School, Finance ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Aarhus University - CREATES ( email )

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

Asger Lunde

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

Aarhus
Denmark

CREATES ( email )

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

James M. Nason

North Carolina State University - Department of Economics ( email )

Campus Box 8110
NC State University
Raleigh, NC 27695-8110
United States
(919) 513-2884 (Phone)
(919) 515-5613 (Fax)

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