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Selecting forecasting models for portfolio allocation

Author

Listed:
  • Adam E Clements

    (QUT)

  • Mark Doolan

    (QUT)

  • Stan Hurn

    (QUT)

  • Ralf Becker

    (University of Manchester)

Abstract

Techniques for evaluating and selecting multivariate volatility forecasts are not yet as well understood as their univariate counterparts. This paper considers the ability of different loss functions to discriminate between a competing set of forecasting models which are subsequently applied in a portfolio allocation context. It is found that a likelihood based loss function outperforms it competitors including those based on the given portfolio application. This result indicates that the particular application of forecasts is not necessarily the most effective approach under which to select models.

Suggested Citation

  • Adam E Clements & Mark Doolan & Stan Hurn & Ralf Becker, 2012. "Selecting forecasting models for portfolio allocation," NCER Working Paper Series 85, National Centre for Econometric Research.
    • Handle: RePEc:qut:auncer:2012_8
    as

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    File URL: http://www.ncer.edu.au/papers/documents/WP85.pdf
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    References listed on IDEAS

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    1. Sébastien Laurent & Jeroen V. K. Rombouts & Francesco Violante, 2012. "On the forecasting accuracy of multivariate GARCH models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 27(6), pages 934-955, September.
    2. Silvennoinen, Annastiina & Teräsvirta, Timo, 2007. "Multivariate GARCH models," SSE/EFI Working Paper Series in Economics and Finance 669, Stockholm School of Economics, revised 18 Jan 2008.
    3. Becker, Ralf & Clements, Adam E., 2008. "Are combination forecasts of S&P 500 volatility statistically superior?," International Journal of Forecasting, Elsevier, vol. 24(1), pages 122-133.
    4. West, Kenneth D. & Edison, Hali J. & Cho, Dongchul, 1993. "A utility-based comparison of some models of exchange rate volatility," Journal of International Economics, Elsevier, vol. 35(1-2), pages 23-45, August.
    5. Hansen, Peter Reinhard & Lunde, Asger, 2006. "Consistent ranking of volatility models," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 97-121.
    6. Engle, Robert F & Sheppard, Kevin K, 2001. "Theoretical and Empirical Properties of Dynamic Conditional Correlation Multivariate GARCH," University of California at San Diego, Economics Working Paper Series qt5s2218dp, Department of Economics, UC San Diego.
    7. Massimiliano Caporin & Michael McAleer, 2010. "Ranking Multivariate GARCH Models by Problem Dimension," CARF F-Series CARF-F-219, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    8. Laurent, Sébastien & Rombouts, Jeroen V.K. & Violante, Francesco, 2013. "On loss functions and ranking forecasting performances of multivariate volatility models," Journal of Econometrics, Elsevier, vol. 173(1), pages 1-10.
    9. Engle, Robert & Colacito, Riccardo, 2006. "Testing and Valuing Dynamic Correlations for Asset Allocation," Journal of Business & Economic Statistics, American Statistical Association, vol. 24, pages 238-253, April.
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    11. Peter Reinhard Hansen & Asger Lunde & James M. Nason, 2003. "Choosing the Best Volatility Models: The Model Confidence Set Approach," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(s1), pages 839-861, December.
    12. Andersen, Torben G. & Bollerslev, Tim & Christoffersen, Peter F. & Diebold, Francis X., 2006. "Volatility and Correlation Forecasting," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 1, chapter 15, pages 777-878, Elsevier.
    13. Patton, Andrew J., 2011. "Volatility forecast comparison using imperfect volatility proxies," Journal of Econometrics, Elsevier, vol. 160(1), pages 246-256, January.
    14. Bollerslev, Tim, 1990. "Modelling the Coherence in Short-run Nominal Exchange Rates: A Multivariate Generalized ARCH Model," The Review of Economics and Statistics, MIT Press, vol. 72(3), pages 498-505, August.
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    Cited by:

    1. Adam Clements & Ayesha Scott & Annastiina Silvennoinen, 2013. "On the Benefits of Equicorrelation for Portfolio Allocation," NCER Working Paper Series 99, National Centre for Econometric Research.

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    More about this item

    Keywords

    Multivariate volatility; portfolio allocation; forecast evaluation; model selection; model confidence set;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G00 - Financial Economics - - General - - - General

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