Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/107858
Year of Publication: 
2014
Series/Report no.: 
Tinbergen Institute Discussion Paper No. 14-147/III
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
In this paper we consider modeling and forecasting of large realized covariance matrices by penalized vector autoregressive models. We propose using Lasso-type estimators to reduce the dimensionality to a manageable one and provide strong theoretical performance guarantees on the forecast capability of our procedure. To be precise, we show that we can forecast future realized covariance matrices almost as precisely as if we had known the true driving dynamics of these in advance. We next investigate the sources of these driving dynamics for the realized covariance matrices of the 30 Dow Jones stocks and find that these dynamics are not stable as the data is aggregated from the daily to the weekly and monthly frequency. The theoretical performance guarantees on our forecasts are illustrated on the Dow Jones index. In particular, we can beat our benchmark by a wide margin at the longer forecast horizons. Finally, we investigate the economic value of our forecasts in a portfolio selection exercise and find that in certain cases an investor is willing to pay a considerable amount in order get access to our forecasts.
Subjects: 
Realized covariance
vector autoregression
shrinkage
Lasso
forecasting
portfolio allocation
JEL: 
C22
Document Type: 
Working Paper

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