Heterogeneous Volatility Cascade in Financial Markets

Discussion in 'Strategy Building' started by stephencrowley, Sep 29, 2005.

  1. Heterogeneous Volatility Cascade in Financial Markets
    Abstract:
    Using high frequency data, we have studied empirically the change of volatility, also called volatility derivative, for various time horizons. In particular, the correlation between the volatility derivative and the volatility realized in the next time period is a measure of the response function of the market participants. This correlation shows explicitly the heterogeneous structure of the market according to the characteristic time horizons of the differents agents. It reveals a volatility cascade from long to short time horizons, with a structure different from the one observed in turbulence. Moreover, we have developed a new ARCH-type model which incorporates the different groups of agents, with their characteristic memory. This model reproduces well the empirical response function, and allows us to quantify the importance of each group.

    Keywords: Econophysics, volatility cascade, market components, ARCH model, turbulence


    What are your thoughts? This, unlike many other academic papers has some very real and useful implications. Volatility is not just one component, it exists on infinitely many timescales. These timescales can be extracted, modeled and forecasted.

    E.g.
    The 1 minute volity, 1 hour, 8 hour, weekly, monthly, yearly, etc.

    At any one point in time all of the modeled volity components contribute a time-varying percentange of the instaneous volatility.

    For example
    1 minute volity 0.30 accuonts for 20%
    1-hour volatility 0.40 accounts for 50%
    and 4-hour volatility 0.35 accuonts for 30%

    Over time, the individual volatilities as well as their contribution vary. Does any of this make sense to you? If so, are you using it for anything useful?