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Realized Volatility and Change of Regimes

Giampiero Gallo () and Edoardo Otranto ()

No 2012_02, Econometrics Working Papers Archive from Universita' degli Studi di Firenze, Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti"

Abstract: Persistence and occasional abrupt changes in the average level characterize the dynamics of high frequency based measures of volatility. Since the beginning of the 2000s, this pattern can be attributed to the dot com bubble, the quiet period of expansion of credit between 2003 and 2006 and then the harsh times after the burst of the subprime mortgage crisis. We conjecture that the inadequacy of many econometric volatility models (a very high level of estimated persistence, serially correlated residuals) can be solved with an adequate representation of such a pattern. We insert a Markovian dynamics in a Multiplicative Error Model to represent the conditional expectation of the realized volatility, allowing us to address the issues of a slow moving average level of volatility and of a different dynamics across regime. We apply the model to realized volatility of the S&P500 index and we gauge the usefulness of such an approach by a more interpretable persistence, better residual properties, and an increased goodness of fit.

Keywords: Multiplicative Error Models; regime switching; realized volatility; volatility persistence (search for similar items in EconPapers)
JEL-codes: C22 C51 C52 C58 (search for similar items in EconPapers)
Pages: 18 pages
Date: 2012-07, Revised 2012-07
New Economics Papers: this item is included in nep-ecm and nep-ets
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