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Forecasting equity index volatility by measuring the linkage among component stocks

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journal contribution
posted on 30.03.2021, 12:43 by Yue QIU, Tian XIE, Jun YU, Qiankun Zhou

The linkage among the realized volatilities of component stocks is important when modeling and forecasting the relevant index volatility. In this article, the linkage is measured via an extended Common Correlated Effects (CCEs) approach under a panel heterogeneous autoregression model where unobserved common factors in errors are assumed. Consistency of the CCE estimator is obtained. The common factors are extracted using the principal component analysis. Empirical studies show that realized volatility models exploiting the linkage effects lead to significantly better out-of-sample forecast performance, for example, an up to 32% increase in the pseudo R2. We also conduct various forecasting exercises on the linkage variables that compare conventional regression methods with popular machine learning techniques.

History

Publication Date

17/01/2021

Journal

Journal of Financial Econometrics

Pages

1-27

ISSN

1479-8409

School

School of Economics

IRIS ID

132534482