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Answering the Critics: Yes, ARCH Models Do Provide Good Volatility Forecasts

Listed author(s):
  • Torben G. Andersen
  • Tim Bollerslev

Volatility permeates modern financial theories and decision making processes. As such, accurate measures and good forecasts of future volatility are critical for the implementation and evaluation of asset pricing theories. In response to this, a voluminous literature has emerged for modeling the temporal dependencies in financial market volatility at the daily and lower frequencies using ARCH and stochastic volatility type models. Most of these studies find highly significant in-sample parameter estimates and pronounced intertemporal volatility persistence. Meanwhile, when judged by standard forecast evaluation criteria, based on the squared or absolute returns over daily or longer forecast horizons, ARCH models provide seemingly poor volatility forecasts. The present paper demonstrates that ARCH models, contrary to the above contention, produce strikingly accurate interdaily forecasts for the latent volatility factor that is relevant for most financial applications.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6023.

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Date of creation: Apr 1997
Publication status: published as Torben G. Andersen and Tim Bollerslev. "Answering the Skeptics: Yes, Standard Volatility Models Do Provide Accurate Forecasts," International Economic Review, 1998, vol. 39, issue 4, pages 885-905
Handle: RePEc:nbr:nberwo:6023
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