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Realized Volatility Risk

  • David E. Allen

    (School of Accounting, Finance and Economics, Edith Cowan University)

  • Michael McAleer

    (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, and Institute of Economic Research, Kyoto University)

  • Marcel Scharth

    (Tinbergen Institute, The Netherlands, Department of Econometrics, VU University Amsterdam)

In this paper we show that realized variation measures constructed from high- frequency returns reveal a large degree of volatility risk in stock and index returns, where we characterize volatility risk by the extent to which forecasting errors in realized volatility are substantive. Even though returns standardized by ex post quadratic variation measures are nearly Gaussian, this unpredictability brings greater uncertainty to the empirically relevant ex ante distribution of returns. Explicitly modeling this volatility risk is fundamental. We propose a dually asymmetric realized volatility model, which incorporates the fact that realized volatility series are systematically more volatile in high volatility periods. Returns in this framework display time varying volatility, skewness and kurtosis. We provide a detailed account of the empirical advantages of the model using data on the S&P 500 index and eight other indexes and stocks.

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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP753.pdf
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Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 753.

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Length: 32pages
Date of creation: Dec 2010
Date of revision:
Handle: RePEc:kyo:wpaper:753
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