The Role of Dynamic Specification in Forecasting Volatility in the Presence of Jumps and Noisy High-Frequency Data

This paper considers the performance of di erent long-memory dynamic models when forecasting volatility in the stock market using implied volatility as an exogenous variable in the information set. Observed volatility is sep- arated into its continuous and jump components in a framework that allo… ws for consistent estimation in the presence of market microstructure noise. A comparison between a class of HAR- and ARFIMA models is facilitated on the basis of out-of-sample forecasting performance. Implied volatility conveys incremental information about future volatility in both specifications, improv- ing performance both in- and out-of-sample for all models. Furthermore, the ARFIMA class of models dominates the HAR specications in terms of out-of- sample performance both with and without implied volatility in the information set. A vectorized ARFIMA (vecARFIMA) model is introduced to control for possible endogeneity issues. This model is compared to a vecHAR specication, re-enforcing the results from the single equation framework.