Realized wavelet-based estimation of integrated variance and jumps in the presence of noise

Jozef Baruník and Lukas Vacha

Quantitative Finance, 2015, vol. 15, issue 8, 1347-1364

Abstract: We introduce wavelet-based methodology for estimation of realized variance allowing its measurement in the time-frequency domain. Using smooth wavelets and maximum overlap discrete wavelet transform, we allow for the decomposition of the realized variance into several investment horizons and jumps. Basing our estimator in the two-scale realized variance framework, we are able to utilize all available data and obtain a feasible estimator in the presence of microstructure noise as well. The estimator is tested in a large numerical study of the finite sample performance and is compared to other popular realized variation estimators. We use different simulation settings with changing noise as well as jump level in different price processes including the long memory fractional stochastic volatility model. The results reveal that our wavelet-based estimator is able to estimate and forecast the realized measures with the greatest precision. Our time-frequency estimators not only produce feasible estimates, but also decompose the realized variation into arbitrarily chosen investment horizons. We apply them to study the volatility of forex futures during the recent crisis at several investment horizons and obtain results which provide us with better understanding of the volatility dynamics.

Date: 2015
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Related works:
Working Paper: Realized wavelet-based estimation of integrated variance and jumps in the presence of noise (2014)
Working Paper: Realized wavelet-based estimation of integrated variance and jumps in the presence of noise (2013)
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DOI: 10.1080/14697688.2015.1032550

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