TD n. 532 2006

Marcelo Medeiros, Marcel Scharth Figueiredo Pinto.

http://dx.doi.org/10.1016/j.ijforecast.2009.01.008

Does volatility reflect a continuous reaction to past shocks or do changes in the markets induce shifts in the volatility dynamics? In this paper, we provide empirical evidence that cumulated price variations convey meaningful information about multiple regimes in the realized volatility of stocks, where large falls (rises) in prices are linked to persistent regimes of high (low) variance in stock returns. Incorporating past cumulated daily returns as an explanatory variable in a flexible and systematic nonlinear framework, we estimate that falls of different magnitudes over less than two months are associated with volatility levels 20% and 60% higher than the average of periods with stable or rising prices. We show that this effect accounts for large empirical values of long memory parameter estimates. Finally, we show that, while introducing more realistic dynamics for volatility, the model is able to overall improve or at least retain out-of-sample performance in forecasting when compared to standard methods. Most importantly, the model is more robust to periods of financial crises, when it attains significantly better forecasts.

Publicado em International Journal of Forecasting, v.25, p. 304-327, 2009