Forecast improvements using a volatility index

Abstract

This paper explores the possibility of improved out of sample forecasting for stock returns and foreign exchange rates using observed nonlinearities in the two series. Forecasting is done using nonparametric techniques where important information is obtained from the current level of volatility in the series. For both series forecast improvements are observed, but for stock returns the improvements are only marginal. These results indicate the usefulness and stability of some types of nonlinear modelling for financial markets.

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