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How Relevant is Volatility Forecasting for Financial Risk Management?

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Author Info
Peter F. Christoffersen
Francis X. Diebold

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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. Moreover, existing assessments of volatility forecastability 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 assumed model. To address this problem, we develop a model-free procedure for assessing 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 short horizons relevant for, say, trading desk management, may not be important for risk management more generally.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6844.

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Date of creation: Dec 1998
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Handle: RePEc:nbr:nberwo:6844

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G1 - Financial Economics - - General Financial Markets
C5 - Mathematical and Quantitative Methods - - Econometric Modeling

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