Why Do Absolute Returns Predict Volatility so Well?

Posted: 16 Jun 2008

See all articles by Lars Forsberg

Lars Forsberg

Uppsala University - Department of Information Science, Division of Statistics

Eric Ghysels

University of North Carolina Kenan-Flagler Business School; University of North Carolina (UNC) at Chapel Hill - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: Winter 2007

Abstract

Our objective is volatility forecasting, which is core to many risk management problems. We provide theoretical explanations for (i) the empirical stylized fact recognized at least since Taylor () and Ding, Granger, and Engle () that absolute returns show more persistence than squared returns and (ii) the empirical finding reported in recent work by Ghysels, Santa-Clara, and Valkanov () showing that realized absolute values outperform square return-based volatility measures in predicting future increments in quadratic variation. We start from a continuous time stochastic volatility model for asset returns suggested by Barndorff-Nielsen and Shephard () and study the persistence and linear regression properties of various volatility-related processes either observed directly or with sampling error. We also allow for jumps in the asset return processes and investigate their impact on persistence and linear regression. Extensive empirical results complement the theoretical analysis.

Keywords: MIDAS regressions, realized variance

Suggested Citation

Forsberg, Lars and Ghysels, Eric, Why Do Absolute Returns Predict Volatility so Well? (Winter 2007). Journal of Financial Econometrics, Vol. 5, Issue 1, pp. 31-67, 2007, Available at SSRN: https://ssrn.com/abstract=1145509 or http://dx.doi.org/10.1093/jjfinec/nbl010

Lars Forsberg (Contact Author)

Uppsala University - Department of Information Science, Division of Statistics ( email )

Box 513
Uppsala, 751 20
Sweden

Eric Ghysels

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Gardner Hall, CB 3305
Chapel Hill, NC 27599
United States
919-966-5325 (Phone)
919-966-4986 (Fax)

HOME PAGE: http://https://eghysels.web.unc.edu/

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