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How Relevant is Volatility Forecasting for Financial Risk Management?

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  • Peter F. Christoffersen
  • Francis X. Diebold

Abstract

It depends. If volatility fluctuates in a forecastable way, then volatility forecasts are useful for risk management; hence the interest in volatility forecastability in the risk management literature. Volatility forecastability, however, varies with horizon, and different horizons are relevant in different applications. Existing assessments are plagued by the fact that they are joint assessments of volatility forecastability and an assumed model, and the results vary not only with the horizon, but also with the model. To address this problem, we develop a model-free procedure for measuring volatility forecastability across horizons. Perhaps surprisingly, we find that volatility forecastability decays quickly with horizon. Volatility forecastability, although clearly of relevance for risk management at the very short horizons relevant for, say, trading desk management, may not be important for risk management more generally.

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Bibliographic Info

Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 98-080.

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Date of creation: 17 Oct 1998
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Handle: RePEc:fth:nystfi:98-080

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Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
Phone: (212) 998-0100
Web page: http://w4.stern.nyu.edu/finance/
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