Evaluating Volatility and Correlation Forecasts.

Working paper

This paper considers the problem of evaluation and comparison of univariate and multivariate volatility forecasts, with explicit attention paid to the fact that in such applications the object of interest is unobservable, even ex post. Thus the evaluation and comparison of volatility forecasts must rely on direct or indirect methods of overcoming this difficulty. Direct methods use a “volatility proxy”, i.e. some observable variable that is related to the latent variable of interest. We will assume the existence of an unbiased volatility proxy, such as daily squared returns for the daily conditional variance of returns. Indirect methods of overcoming the latent nature of the variable of interest include comparing forecasts via mean-variance portfolio decisions or comparisons based on portfolio “tracking error”.

Authors: Patton, A; Sheppard, K

• Publisher: Oxford-Man Institute of Quantitative Finance
• Series: Working Papers
• Publication date: 2007-10-29
• Language: English