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Forecasting Co-Volatilities via Factor Models with Asymmetry and Long Memory in Realized Covariance

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Modelling covariance structures is known to suffer from the curse of dimensionality. In order to avoid this problem for forecasting, the authors propose a new factor multivariate stochastic volatility (fMSV) model for realized covariance measures that accommodates asymmetry and long memory. Using the basic structure of the fMSV model, the authors extend the dynamic correlation MSV model, the onditional/stochastic Wishart autoregressive models, the matrix-exponential MSV model, and the Cholesky MSV model. Empirical results for 7 financial asset returns for US stock returns indicate that the new fMSV models outperform existing dynamic conditional correlation models for forecasting future covariances. Among the new fMSV models, the Cholesky MSV model with long memory and asymmetry shows stable and better forecasting performance for one-day, five-day and ten-day horizons in the periods before, during and after the global financial crisis.

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Paper provided by Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico in its series Documentos de Trabajo del ICAE with number 2014-05.

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Length: 38 pages
Date of creation: Mar 2014
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Handle: RePEc:ucm:doicae:1405

Note: The authors are most grateful to Yoshi Baba for very helpful comments and suggestions. The first author acknowledges the financial support of the Japan Ministry of Education, Culture, Sports, Science and Technology, Japan Society for the Promotion of Science, and Australian Academy of Science. The second author is most grateful for the financial support of the Australian Research Council, National Science Council, Taiwan, and the Japan Society for the Promotion of Science. Address for correspondence: Faculty of Economics, Soka University, 1-236 Tangi-cho, Hachioji, Tokyo 192-8577, Japan. Email address: m-asai@soka.ac.jp.
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Keywords: Dimension reduction; Factor Model; Multivariate Stochastic Volatility; Leverage Effects; Long Memory; Realized Volatility.;

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