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Some Like it Smooth, and Some Like it Rough: Untangling Continuous and Jump Components in Measuring, Modeling, and Forecasting Asset Return Volatility

By Torben G. Andersen, Tim Bollerslev and Francis X. Diebold

Abstract

A rapidly growing literature has documented important improvements in volatility measurement and forecasting performance through the use of realized volatilities constructed from highfrequency returns coupled with relatively simple reduced-form time series modeling procedures. Building on recent theoretical results from Barndorff-Nielsen and Shephard (2003b, 2004a) for related bipower variation measures involving the sum of high-frequency absolute returns, the present paper provides a practical framework for non-parametrically measuring the jump component in realized volatility measurements. Exploiting these ideas for a decade of high-frequency five-minute returns for the DM/ $ exchange rate, the S&P500 market index, and the 30-year U.S. Treasury bond yield, we find the jump component of the price process to be distinctly less persistent than the continuous sample path component. Explicitly including the jump measure as an additional explanatory variable in an easy-toimplement reduced form model for realized volatility results in highly significant jump coefficient estimates at the daily, weekly and quarterly forecast horizons. As such, our results hold promise for improved financial asset allocation, risk management, and derivatives pricing, by separate modeling, forecasting and pricing of the continuous and jump components of total return variability

Topics: JEL Codes, C1, G1 Correspondence, Send all correspondence to Bollerslev
Year: 2003
OAI identifier: oai:CiteSeerX.psu:10.1.1.198.8133
Provided by: CiteSeerX
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