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Smooth and Abrupt Dynamics in Financial Volatility: the MS-MEM-MIDAS

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  • L. Scaffidi Domianello
  • G.M. Gallo
  • E. Otranto

Abstract

In this paper we remark that the evolution of the realized volatility is characterized by a combination between high–frequency dynamics and a smoother persistent dynamics evolving at a lower–frequency. We suggest a new Multiplicative Error Model which combines the mixed frequency features of a MIDAS with Markovian dynamics. When estimated in–sample on the realized kernel volatility of the S&P500 index, this model dominates other simpler specifications, especially when monthly aggregated realized volatility is used. The same pattern is confirmed in the out–of–sample forecasting performance which suggests that adding an abrupt change in the average level of volatility better helps in tracking extreme episodes of volatility and a relative quick absorption of the shocks.

Suggested Citation

  • L. Scaffidi Domianello & G.M. Gallo & E. Otranto, 2022. "Smooth and Abrupt Dynamics in Financial Volatility: the MS-MEM-MIDAS," Working Paper CRENoS 202205, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
    • Handle: RePEc:cns:cnscwp:202205
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    More about this item

    Keywords

    Short– and Long–Run Components; realized volatility; Multiplicative Error Model; MIDAS; markov switching;
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