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A model-free approach to do long-term volatility forecasting and its variants

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  • Kejin Wu

    (University of California San Diego)

  • Sayar Karmakar

    (University of Florida)

Abstract

Volatility forecasting is important in financial econometrics and is mainly based on the application of various GARCH-type models. However, it is difficult to choose a specific GARCH model that works uniformly well across datasets, and the traditional methods are unstable when dealing with highly volatile or short-sized datasets. The newly proposed normalizing and variance stabilizing (NoVaS) method is a more robust and accurate prediction technique that can help with such datasets. This model-free method was originally developed by taking advantage of an inverse transformation based on the frame of the ARCH model. In this study, we conduct extensive empirical and simulation analyses to investigate whether it provides higher-quality long-term volatility forecasting than standard GARCH models. Specifically, we found this advantage to be more prominent with short and volatile data. Next, we propose a variant of the NoVaS method that possesses a more complete form and generally outperforms the current state-of-the-art NoVaS method. The uniformly superior performance of NoVaS-type methods encourages their wide application in volatility forecasting. Our analyses also highlight the flexibility of the NoVaS idea that allows the exploration of other model structures to improve existing models or solve specific prediction problems.

Suggested Citation

  • Kejin Wu & Sayar Karmakar, 2023. "A model-free approach to do long-term volatility forecasting and its variants," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 9(1), pages 1-38, December.
  • Handle: RePEc:spr:fininn:v:9:y:2023:i:1:d:10.1186_s40854-023-00466-6
    DOI: 10.1186/s40854-023-00466-6
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    Cited by:

    1. Kejin Wu & Sayar Karmakar, 2023. "GARHCX-NoVaS: A Model-free Approach to Incorporate Exogenous Variables," Papers 2308.13346, arXiv.org.
    2. Kejin Wu & Sayar Karmakar & Rangan Gupta & Christian Pierdzioch, 2023. "Climate Risks and Stock Market Volatility Over a Century in an Emerging Market Economy: The Case of South Africa," Working Papers 202326, University of Pretoria, Department of Economics.

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