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Modelling and Forecasting Noisy Realized Volatility

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Author Info

  • Manuabu Asai
  • Michael McAleer

    ()
    (University of Canterbury)

  • Marcelo C. Medeiros

Abstract

Several methods have recently been proposed in the ultra high frequency financial literature to remove the effects of microstructure noise and to obtain consistent estimates of the integrated volatility (IV) as a measure of ex-post daily volatility. Even bias-corrected and consistent (modified) realized volatility (RV) estimates of the integrated volatility can contain residual microstructure noise and other measurement errors. Such noise is called “realized volatility error”. Since such measurement errors are ignored, we need to take account of them in estimating and forecasting IV. This paper investigates through Monte Carlo simulations the effects of RV errors on estimating and forecasting IV with RV data. It is found that: (i) neglecting RV errors can lead to serious bias in estimators due to model misspecification; (ii) the effects of RV errors on one-step ahead forecasts are minor when consistent estimators are used and when the number of intraday observations is large; and (iii) even the partially corrected recently proposed in the literature should be fully corrected for evaluating forecasts. This paper proposes a full correction of , which can be applied to linear and nonlinear, short and long memory models. An empirical example for S&P 500 data is used to demonstrate that neglecting RV errors can lead to serious bias in estimating the model of integrated volatility, and that the new method proposed here can eliminate the effects of the RV noise. The empirical results also show that the full correction for is necessary for an accurate description of goodness-of-fit.

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File URL: http://www.econ.canterbury.ac.nz/RePEc/cbt/econwp/1021.pdf
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Bibliographic Info

Paper provided by University of Canterbury, Department of Economics and Finance in its series Working Papers in Economics with number 10/21.

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Length: 41 pages
Date of creation: 01 May 2010
Date of revision:
Handle: RePEc:cbt:econwp:10/21

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Keywords: Realized volatility; diffusion; financial econometrics; measurement errors; forecasting; model evaluation; goodness-of-fit;

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References

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Cited by:
  1. Stefano Grassi & Paolo Santucci de Magistris, 2013. "It’s all about volatility (of volatility): evidence from a two-factor stochastic volatility model," CREATES Research Papers 2013-03, School of Economics and Management, University of Aarhus.
  2. Hwang, Eunju & Shin, Dong Wan, 2013. "A CUSUM test for a long memory heterogeneous autoregressive model," Economics Letters, Elsevier, vol. 121(3), pages 379-383.

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