The Economic Value of Volatility Forecasts: A Conditional Approach

We investigate the economic value of multivariate volatility forecasting ability using a testing framework that assesses the quality of competing methods from a conditional investment perspective. This approach provides a novel means of assessing the benefits of using a particular set of volatility forecasts. Applying the framework to U.S. bond and stock futures markets, we find that investors are willing to pay a significant premium for knowledge of the dynamics of volatility, though the magnitude of this premium varies over time and depends on risk preferences and economic conditions. The latter variation implies that selection of appropriate forecasting methods should be a conditional exercise.