What should the value of lambda be in the exponentially weighted moving average volatility model?

Title
What should the value of lambda be in the exponentially weighted moving average volatility model?
Publication Date
2015
Author(s)
Bollen, Bernard
Type of document
Journal Article
Language
en
Entity Type
Publication
Publisher
Routledge
Place of publication
United Kingdom
DOI
10.1080/00036846.2014.982853
UNE publication id
une:16607
Abstract
Forecasting volatility is fundamental to forecasting parametric models of value-at-risk. The exponentially weighted moving average (EWMA) volatility model is the recommended model for forecasting volatility by the Riskmetrics group. For monthly data, the lambda parameter of the EWMA model is recommended to be set to 0.97. In this study, we empirically investigate if this is the optimal value of lambda in terms of forecasting volatility. Employing monthly realized volatility as the benchmark for testing the value of lambda, it is found that a value of lambda of 0.97 is far from optimal. The tests are robust to a variety of test statistics. It is further found that the optimal value of lambda is time varying and should be based upon recent historical data. The article offers a practical method to increase the reliability and accuracy of value-at-risk forecasts that can be easily implemented within an Excel spreadsheet.
Link
Citation
Applied Economics, 47(8), p. 853-860
ISSN
1466-4283
0003-6846
Start page
853
End page
860

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