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A Reduced Form Framework for Modeling Volatility of Speculative Prices based on Realized Variation Measures

Author

Listed:
  • Torben G. Andersen
  • Tim Bollerslev
  • Xin Huang

    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

Abstract
Building on realized variance and bi-power variation measures constructed from high-frequency financial prices, we propose a simple reduced form framework for effectively incorporating intraday data into the modeling of daily return volatility. We decompose the total daily return variability into the continuous sample path variance, the variation arising from discontinuous jumps that occur during the trading day, as well as the overnight return variance. Our empirical results, based on long samples of high-frequency equity and bond futures returns, suggest that the dynamic dependencies in the daily continuous sample path variability is well described by an approximate long-memory HAR-GARCH model, while the overnight returns may be modelled by an augmented GARCH type structure. The dynamic dependencies in the non-parametrically identified significant jumps appear to be well described by the combination of an ACH model for the time-varying jump intensities coupled with a relatively simple log-linear structure for the jump sizes. Lastly, we discuss how the resulting reduced form model structure for each of the three components may be used in the construction of out-of-sample forecasts for the total return volatility.

Suggested Citation

  • Torben G. Andersen & Tim Bollerslev & Xin Huang, 2007. "A Reduced Form Framework for Modeling Volatility of Speculative Prices based on Realized Variation Measures," CREATES Research Papers 2007-14, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:create:2007-14
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    References listed on IDEAS

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    More about this item

    Keywords

    Stochastic Volatility; Realized Variation; Bipower Variation; Jumps; Hazard Rates; Overnight Volatility;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • G1 - Financial Economics - - General Financial Markets
    • C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables

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