Forecasting Nonlinear Functions of Returns Using LINEX Loss Functions
Soosung Hwang (),
John Knight and
Stephen Satchell Additional contact information John Knight: Department of Economics, University of Western Ontario
Stephen Satchell: Trinity College and Faculty of Economics and Politics, University of Cambridge
This paper applies LINEX loss functions to forecasting nonlinear functions of variance. We derive the optimal one-step-ahead LINEX forecast for various volatility models using data transformations such as ln(y2t) where yt is the return of the asset. Our results suggest that the LINEX loss function is particularly well-suited to many of these forecasting problems and can give better forecasts than conventional loss functions such as mean square error (MSE).