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Robust forecasting of dynamic conditional correlation GARCH models

  • Boudt, Kris
  • Daníelsson, Jón
  • Laurent, Sébastien

Large one-off events cause large changes in prices, but may not affect the volatility and correlation dynamics as much as smaller events. In such cases, standard volatility models may deliver biased covariance forecasts. We propose a multivariate volatility forecasting model that is accurate in the presence of large one-off events. The model is an extension of the dynamic conditional correlation (DCC) model. In our empirical application to forecasting the covariance matrix of the daily EUR/USD and Yen/USD return series, we find that our method produces more precise out-of-sample covariance forecasts than the DCC model. Furthermore, when used in portfolio allocation, it leads to portfolios with similar return characteristics but lower turnovers, and hence higher profits.

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File URL: http://www.sciencedirect.com/science/article/pii/S0169207012000878
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Article provided by Elsevier in its journal International Journal of Forecasting.

Volume (Year): 29 (2013)
Issue (Month): 2 ()
Pages: 244-257

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Handle: RePEc:eee:intfor:v:29:y:2013:i:2:p:244-257
DOI: 10.1016/j.ijforecast.2012.06.003
Contact details of provider: Web page: http://www.elsevier.com/locate/ijforecast

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