Robust forecasting of dynamic conditional correlation GARCH models

K. Boudt, J. Danielsson, S.F.J.A. Laurent

Research output: Contribution to journalArticleAcademicpeer-review

Abstract

Large one-off events cause large changes in prices, but may not affect the volatility and correlation dynamics as much as smaller events. In such cases, standard volatility models may deliver biased covariance forecasts. We propose a multivariate volatility forecasting model that is accurate in the presence of large one-off events. The model is an extension of the dynamic conditional correlation (DCC) model. In our empirical application to forecasting the covariance matrix of the daily EUR/USD and Yen/USD return series, we find that our method produces more precise out-of-sample covariance forecasts than the DCC model. Furthermore, when used in portfolio allocation, it leads to portfolios with similar return characteristics but lower turnovers, and hence higher profits. (C) 2012 International Institute of Forecasters. Published by Elsevier B.V. All rights reserved.
Original languageEnglish
Pages (from-to)244-257
Number of pages14
JournalInternational Journal of Forecasting
Volume29
Issue number2
DOIs
Publication statusPublished - 1 Jan 2013

Keywords

  • Jumps
  • Conditional covariance
  • Forecasting
  • EXCHANGE-RATES
  • VOLATILITY
  • OUTLIERS
  • ESTIMATORS
  • SHARPE
  • RETURN

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