Forecasting Exchange Rate Volatility. Applying HAR models and Implied Volatility in SEK denominated markets

Abstract

In this paper we study a set of models' forecasting accuracy of realized volatility in two SEK denominated exchange rates, EUR/SEK and USD/SEK, with the purpose to analyze if ex-post or ex-ante forecasting models produce the most accurate forecasts. High-frequency exchange rate data is employed in order to construct the ex-post Heterogeneous Autoregressive Model of Realized Volatility, HAR-RV, as well as a modi ed model using the bipower and tripower variation to separate the continuous sample path (C) and the jump component (J) of realized volatility, HAR-CJ. The forecasting accuracy of the ex-ante implied volatility estimate (IV) is also evaluated, based on daily OTC data and regarded as the option market's forecast of future volatility. The forecasts are conducted applying in-sample and out-of-sample tests over two horizons, one week and one month. Our ndings do not provide clear evidence whether to rely solely on the ex-ante or ex-post estimate when forecasting exchange rate volatility. Rather, the model combining ex-post and ex-ante information, HAR-RV-IV, consistently provides good forecasting results.