Statistical Surveillance of Volatility Forecasting Models

This paper elaborates sequential procedures for monitoring the validity of a volatility model. A state-space representation describes dynamics of daily integrated volatility. The observation equation relates the integrated volatility to its measures such as the realized volatility or bipower variation. On-line control procedures, based on volatility forecasting errors, allow us to decide whether the chosen representation remains correctly specified. A signal indicates that the assumed volatility model may no longer be valid. The performance of our approach is analyzed within a Monte Carlo simulation study and illustrated in an empirical application for selected U.S. stocks. Copyright The Author 2011. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.