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Journal of Financial Econometrics Advance Access originally published online on September 19, 2008
Journal of Financial Econometrics 2008 6(4):513-539; doi:10.1093/jjfinec/nbn012
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© The Author 2008. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

On Variable Selection for Volatility Forecasting: The Role of Focused Selection Criteria

Christian T. Brownlees and Giampiero M. Gallo
     Università di Firenze, Firenze, Italy and FEDRA

Address correspondence to Giampiero M. Gallo, Dipartimento di Statistica "G. Parenti", Università di Firenze, Viale G.B. Morgagni 59, I-50134 Firenze, Italy, or e-mail: gallog{at}ds.unifi.it

JEL Classification: C22, C52, C53


  Abstract

This paper is concerned with the issues of modeling and projecting the dynamics of volatility when a group of potentially useful predetermined variables is available. We predict realized volatility and value at risk (VaR) with a nested set of multiplicative error models for realized volatility. We make use of recently proposed focused model selection/combination strategies as well as the classic AIC/BIC. Focused strategies consist of choosing the model that minimizes the estimated MSE of a given function of the parameters of interest to the forecaster. Results show that VaR forecasts can significantly be improved upon using focused prediction strategies.

KEYWORDS: focused information criteria, forecasting, model selection, realized volatility, value at risk

We would like to thank the Editor René Garcia, the Associate Editor, and two anonymous referees for a very careful reading of the earlier version of the paper circulated under the title "Volatility Forecasting Using Explanatory Variables and Focused Selection Criteria". Their detailed comments helped us to substantially improve our presentation. The usual disclaimer applies. Financial support from the Italian MIUR under grant 2006137221_001 is gratefully acknowledged.

Received June 4, 2007; revised August 1, 2008; accepted August 8, 2008


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