Measuring and modeling risk using high-frequency data

Abstract

Volatility modelling is the key to the theory and practice of pricing financial products. Asset allocation and portfolio as well as risk management depend heavily on a correct modelling of the underlying(s). This insight has spurred extensive research in financial econometrics and mathematical finance. Stochastic volatility models with separate dynamic structure for the volatility process have been in the focus of the mathematical finance literature, see Heston (1993) and Bates (2000), while parametric GARCH-type models for the returns of the underlying(s) have been intensively analyzed in financial econometrics. The validity of these models in practice though depends upon specific distributional properties or the knowledge of the exact (parametric) form of the volatility dynamics. Moreover, the evaluation of the predictive ability of volatility models is quite important in empirical applications. However, the latent character of the volatility poses a problem. To what measure should the volatility forecasts be compared to? Conventionally, the forecasts of daily volatility models, such as GARCH-type or stochastic volatility models, have been evaluated with respect to absolute or squared daily returns. In view of the excellent in-sample performance of these models, the forecasting performance, however, seems to be disappointing. © 2008 Springer-Verlag Berlin Heidelberg.