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Large volatility matrix inference via combining low-frequency and high-frequency approaches

Tao, Minjing, Wang, Yahzen, Yao, Qiwei and Zou, Jian (2011) Large volatility matrix inference via combining low-frequency and high-frequency approaches. Journal of the American Statistical Association, 106 (495). pp. 1025-1040. ISSN 0162-1459

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Abstract

It is increasingly important in financial economics to estimate volatilities of asset returns. However, most of the available methods are not directly applicable when the number of assets involved is large, due to the lack of accuracy in estimating high-dimensional matrices. Therefore it is pertinent to reduce the effective size of volatility matrices in order to produce adequate estimates and forecasts. Furthermore, since high-frequency financial data for different assets are typically not recorded at the same time points, conventional dimension-reduction techniques are not directly applicable. To overcome those difficulties we explore a novel approach that combines high-frequency volatility matrix estimation together with low-frequency dynamic models. The proposed methodology consists of three steps: (i) estimate daily realized covolatility matrices directly based on high-frequency data, (ii) fit a matrix factor model to the estimated daily covolatility matrices, and (iii) fit a vector autoregressive model to the estimated volatility factors.We establish the asymptotic theory for the proposed methodology in the framework that allows sample size, number of assets, and number of days go to infinity together. Our theory shows that the relevant eigenvalues and eigenvectors can be consistently estimated. We illustrate the methodology with the high-frequency price data on several hundreds of stocks traded in Shenzhen and Shanghai Stock Exchanges over a period of 177 days in 2003. Our approach pools together the strengths of modeling and estimation at both intra-daily (high-frequency) and inter-daily (low-frequency) levels.

Item Type: Article
Official URL: http://pubs.amstat.org/loi/jasa
Additional Information: © 2011 American Statistical Association
Library of Congress subject classification: H Social Sciences > HA Statistics
Sets: Departments > Statistics
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Funders: National Science Foundation, Engineering and Physical Sciences Research Council, Engineering and Physical Sciences Research Council
Projects: DMS-105635, EP/C549058/1, EP/H010408/1
Date Deposited: 08 Nov 2011 15:35
URL: http://eprints.lse.ac.uk/39321/

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