A No Arbitrage Fractional Cointegration Analysis Of The Range Based Volatility

Eduardo Rossi () and Paolo Santucci de Magistris
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Paolo Santucci de Magistris: Dipartimento di economia politica e metodi quantitativi, University of Pavia, Italy, Postal: Dipartimento di economia politica e metodi quantitativi, University of Pavia, Italy

CREATES Research Papers from School of Economics and Management, University of Aarhus

Abstract: The no arbitrage relation between futures and spot prices implies an analogous relation between futures and spot volatilities as measured by daily range. Long memory features of the range-based volatility estimators of the two series are analyzed, and their joint dynamics are modeled via a fractional vector error correction model (FVECM), in order to explicitly consider the no arbitrage constraints. We introduce a two-step estimation procedure for the FVECM parameters and we show the properties by a Monte Carlo simulation. The out-of-sample forecasting superiority of FVECM, with respect to competing models, is documented. The results highlight the importance of giving fully account of long-run equilibria in volatilities in order to obtain better forecasts.

Keywords: Range-based volatility estimator; Long memory; Fractional cointegration; Fractional VECM; Stock Index Futures (search for similar items in EconPapers)
JEL-codes: C32 C13 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm and nep-for
Date: 2009-07-15
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