The role of model bias in predicting volatility: evidence from the US equity markets

Yan Li, Lian Luo, Chao Liang and Feng Ma

China Finance Review International, 2020, vol. 13, issue 1, 140-155

Abstract: Purpose - The purpose of this paper is to explore whether the out-of-sample model bias plays an important role in predicting volatility. Design/methodology/approach - Under the heterogeneous autoregressive realized volatility (HAR-RV) framework, we analyze the predictive power of out-of-sample model bias for the realized volatility (RV) of the Dow Jones Industrial Average (DJI) and the S&P 500 (SPX) indices from in-sample and out-of-sample perspectives respectively. Findings - The in-sample results reveal that the prediction model including the model bias can obtain biggerR2, and the out-of-sample empirical results based on several evaluation methods suggest that the prediction model incorporating model bias can improve forecast accuracy for the RV of the DJI and the SPX indices. That is, model bias can enhance the predictability of original HAR family models. Originality/value - The author introduce out-of-sample model bias into HAR family models to enhance model capability in predicting realized volatility.

Keywords: Realized volatility; Model bias; Volatility forecasting; Equity markets; C22; C52; C55 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:cfripp:cfri-04-2020-0037

DOI: 10.1108/CFRI-04-2020-0037

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