Volatility Forecast Comparison Using Imperfect Volatility Proxies

University of Technology Quantitative Finance Research Centre Research Paper No. 175

45 Pages Posted: 2 Apr 2010

See all articles by Andrew J. Patton

Andrew J. Patton

Duke University - Department of Economics

Date Written: April 1, 2006

Abstract

The use of a conditionally unbiased, but imperfect, volatility proxy can lead to undesirable outcomes in standard methods for comparing conditional variance forecasts. We derive necessary and sufficient conditions on functional form of the loss function for the ranking of competing volatility forecasts to be robust to the presence of noise in the volatility proxy, and derive some interesting special cases of this class of "robust" loss functions. We motivate the theory with analytical results on the distortions caused by some widely-used loss functions, when used with standard volatility proxies such as squared returns, the intra-daily range or realised volatility. The methods are illustrated with an application to the volatility of returns on IBM over the period 1993 to 2003.

Keywords: Forecast Evaluation, Forecast Comparison, Loss Functions, Realised Variance, Range

JEL Classification: C53, C52, C22

Suggested Citation

Patton, Andrew J., Volatility Forecast Comparison Using Imperfect Volatility Proxies (April 1, 2006). University of Technology Quantitative Finance Research Centre Research Paper No. 175. Available at SSRN: https://ssrn.com/abstract=932890 or http://dx.doi.org/10.2139/ssrn.932890

Andrew J. Patton (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

HOME PAGE: http://econ.duke.edu/~ap172/

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