A No Arbitrage Fractional Cointegration Analysis Of The Range Based Volatility

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A No Arbitrage Fractional Cointegration Analysis Of The Range Based Volatility

Author Info

Eduardo Rossi () (Dipartimento di economia politica e metodi quantitativi, University of Pavia, Italy.)
Paolo Santucci de Magistris (Dipartimento di economia politica e metodi quantitativi, University of Pavia, Italy)

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Eduardo Rossi

Abstract

The no arbitrage relation between futures and spot prices implies an analogous relation between futures and spot volatilities as measured by daily range. Long memory features of the range-based volatility estimators of the two series are analyzed, and their joint dynamics are modeled via a fractional vector error correction model (FVECM), in order to explicitly consider the no arbitrage constraints. We introduce a two-step estimation procedure for the FVECM parameters and we show the properties by a Monte Carlo simulation. The out-of-sample forecasting superiority of FVECM, with respect to competing models, is documented. The results highlight the importance of giving fully account of long-run equilibria in volatilities in order to obtain better forecasts.

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Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2009-31.

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Length: 34
Date of creation: 15 Jul 2009
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Handle: RePEc:aah:create:2009-31

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Find related papers by JEL classification:
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Estimation
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-08-16 (All new papers)
NEP-ECM-2009-08-16 (Econometrics)
NEP-FOR-2009-08-16 (Forecasting)

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