Forecasting volatility with time-varying leverage and volatility of volatility effects

Leopoldo Catania and Tommaso Proietti

International Journal of Forecasting, 2020, vol. 36, issue 4, 1301-1317

Abstract: Predicting volatility is of primary importance for business applications in risk management, asset allocation, and the pricing of derivative instruments. This paper proposes a measurement model that considers the possibly time-varying interaction of realized volatility and asset returns according to a bivariate model to capture its major characteristics: (i) the long-term memory of the volatility process, (ii) the heavy-tailedness of the distribution of returns, and (iii) the negative dependence of volatility and daily market returns. We assess the relevance of the effects of “the volatility of volatility” and time-varying “leverage” to the out-of-sample forecasting performance of the model, and evaluate the density of forecasts of market volatility. Empirical results show that our specification can outperform the benchmark HAR–GARCH model in terms of both point and density forecasts.

Keywords: Realized volatility; Leverage effect; Volatility of volatility; Score driven models; Volatility prediction (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (8)

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Related works:
Working Paper: Forecasting Volatility with Time-Varying Leverage and Volatility of Volatility Effects (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfor:v:36:y:2020:i:4:p:1301-1317

DOI: 10.1016/j.ijforecast.2020.01.003

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