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Structural breaks in unbiased volatility estimator: Modeling and forecasting

Dilip Kumar

Abstract


The study provides a framework to model the unbiased extreme value volatility estimator (The AddRS estimator) in presence of structural breaks. We observe that the structural breaks in the volatility based on the AddRS estimator can partly explain its long memory property. We evaluate the forecasting performance of the proposed framework and compare the results with the corresponding results of the models from the GARCH family. The forecasts evaluation exercises consider the cases when future breaks are known as well as unknown. Our findings indicate that the proposed framework outperform the sophisticated GARCH class of models in forecasting realized volatility. Moreover, we devise a trading strategy based on the forecasts of the variance to highlight the economic significance of the proposed framework. We find that a risk averse investor can make substantial gain using the volatility forecasts based on the proposed frameworks in comparison to the GARCH family of models.


Keywords


Volatility modeling; Structural breaks; Volatility forecasting; Forecast evaluation; Bias corrected extreme value estimator.

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References


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DOI: http://dx.doi.org/10.5750/jpm.v11i1.1239

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