Forecasting conditional correlations in stock, bond and foreign exchange markets

The paper forecasts conditional correlations between three classes of international financial assets, namely stock, bond and foreign exchange. Two countries are considered, namely Australia and New Zealand. Forecasting will be conducted using three multivariate GARCH models, namely the CCC model [T. Bollerslev, Modelling the coherence in short-run nominal exchange rates: a multivariate generalized ARCH model, Rev. Econ. Stat. 72 (1990) 498–505], VARMA-GARCH model [S. Ling, M. McAleer, Asymptotic theory for a vector ARMA-GARCH model, Econometric Theory 19 (2003) 280–310], and VARMA-AGARCH model [M. McAleer, S. Hoti, F. Chan, Structure and asymptotic theory for multivariate asymmetric volatility, Econometric Rev., in press]. A rolling window technique is used to forecast 1-day ahead conditional correlations. To evaluate the impact of model specification on conditional correlations forecasts, this paper calculates and compares the correlations between conditional correlations forecasts resulted from the three models. The paper finds the evidence of volatility spillovers and asymmetric effect of negative and positive shock on the conditional variance in most pairs of series. However, it suggests that incorporating volatility spillovers and asymmetric do not contribute to better conditional correlations forecasts.