The Economic Value of Volatility Timing Using 'Realized' Volatility

Recent work suggests that intradaily returns can be used to construct estimates of daily return volatility that are more precise than those constructed using daily returns. We measure the economic value of this "realized" volatility approach in the context of investment decisions. Our results indicate that the value of switching from daily to intradaily returns to estimate the conditional covariance matix can be substantial. We estimate that a risk-averse investor would be willing to pay 50 to 200 basis points per year to capture the observed gains in portfolio performance. Moreover,these gains are robust to transaction costs, estimation risk regarding expected returns, and the performance measurement horizon.

[1]  P. Clark.  A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices , 1973 .

[2]  R. C. Merton,et al.  On Estimating the Expected Return on the Market: An Exploratory Investigation , 1980 .

[3]  T. Bollerslev,et al.  Generalized autoregressive conditional heteroskedasticity , 1986 .

[4]  David Hsieh.  Chaos and Nonlinear Dynamics: Application to Financial Markets , 1991 .

[5]  Daniel B. Nelson.  CONDITIONAL HETEROSKEDASTICITY IN ASSET RETURNS: A NEW APPROACH , 1991 .

[6]  Dean P. Foster,et al.  Continuous Record Asymptotics for Rolling Sample Variance Estimators , 1994 .

[7]  R. Engle,et al.  Multivariate Simultaneous Generalized ARCH , 1995, Econometric Theory.

[8]  P. Hall,et al.  BOOTSTRAP CRITICAL VALUES FOR TESTS BASED ON , 1996 .

[9]  Jeff Fleming,et al.  Trading Costs and the Relative Rates of Price Discovery in Stock, Futures, and Option Markets , 1996 .

[10]  Joel L. Horowitz,et al.  Bootstrap Critical Values for Tests Based on Generalized-Method-of-Moments Estimators , 1996 .

[11]  T. Bollerslev,et al.  ANSWERING THE SKEPTICS: YES, STANDARD VOLATILITY MODELS DO PROVIDE ACCURATE FORECASTS* , 1998 .

[12]  G. Mason,et al.  Beyond Merton’s Utopia: Effects of Non-normality and Dependence on the Precision of Variance Estimates Using High-frequency Financial Data , 2000 .

[13]  Nelson Areal,et al.  The Realized Volatility of Ftse-100 Futures Prices , 2000 .

[14]  N. Shephard,et al.  Non-Gaussian OU based models and some of their uses in financial economics , 2000 .

[15]  Chris Kirby,et al.  The Economic Value of Volatility Timing , 2000 .

[16]  Francis X. Diebold,et al.  Modeling and Forecasting Realized Volatility , 2001 .

[17]  F. Diebold,et al.  The Distribution of Realized Exchange Rate Volatility , 2000 .

[18]  F. Diebold,et al.  The distribution of realized stock return volatility , 2001 .

[19]  Eric Ghysels,et al.  Rolling-Sample Volatility Estimators , 2002 .

[20]  N. Shephard,et al.  Econometric analysis of realized volatility and its use in estimating stochastic volatility models , 2002 .