This paper develops a novel approach to modeling and forecasting realized volatility (RV) measures based on copula functions. Copula-based time series models can capture relevant characteristics of volatility such as nonlinear dynamics and long-memory type behavior in a flexible yet parsimonious way. In an empirical application to daily volatility for S&P500 index futures, we find that the copula-based RV (C-RV) model outperforms conventional forecasting approaches for one-day ahead volatility forecasts in terms of accuracy and efficiency. Among the copula specifications considered, the Gumbel C-RV model achieves the best forecast performance, which highlights the importance of asymmetry and upper tail dependence for modeling volatility dynamics. Although we find substantial variation in the copula parameter estimates over time, conditional copulas do not improve the accuracy of volatility forecasts.

Nonlinear dependence, copula, long memory, volatility forecasting
Time-Series Models; Dynamic Quantile Regressions (jel C22), Forecasting and Other Model Applications (jel C53), Financial Forecasting (jel G17)
Tinbergen Institute
hdl.handle.net/1765/26086
Tinbergen Institute Discussion Paper Series
Discussion paper / Tinbergen Institute
Erasmus School of Economics

Sokolinskiy, O, & van Dijk, D.J.C. (2011). Forecasting Volatility with Copula-Based Time Series Models (No. TI 2011-125/4). Discussion paper / Tinbergen Institute (pp. 1–30). Tinbergen Institute. Retrieved from http://hdl.handle.net/1765/26086