Long Memory versus Structural Breaks in Modeling and Forecasting Realized Volatility

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Long Memory versus Structural Breaks in Modeling and Forecasting Realized Volatility

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Kyongwook Choi (Department of Economics, The University of Seoul,)
Wei-Choun Yu (Economics and Finance Department, Winona State University)
Eric Zivot (Department of Economics, University of Washington)

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Wei-Choun Yu

Abstract

We explore the possibility of structural breaks in realized volatility with observed long-memory properties for the daily Deutschemark/Dollar, Yen/Dollar and Yen/Deutschemark spot exchange rate realized volatility. We find that structural breaks can partly explain the persistence of realized volatility. We propose a VAR-RV-Break model that provides superior predictive ability compared to most of the forecasting models when the future break is known. With unknown break dates and sizes, we find that the VAR-RV-I(d) long memory model, however, is a very robust forecasting method even when the true financial volatility series are generated by structural breaks.

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Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2008-20.

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Date of creation: Sep 2008
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Handle: RePEc:udb:wpaper:uwec-2008-20

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This paper has been announced in the following NEP Reports:

NEP-ALL-2008-11-25 (All new papers)
NEP-ECM-2008-11-25 (Econometrics)
NEP-ETS-2008-11-25 (Econometric Time Series)
NEP-FOR-2008-11-25 (Forecasting)

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