Predicting stock index volatility: can market volume help?

This paper explores a number of statistical models for predicting the daily stock return volatility of an aggregate of all stocks traded on the NYSE. An application of linear and non-linear Granger causality tests highlights evidence of bidirectional causality, although the relationship is stronger from volatility to volume than the other way around. The out-of-sample forecasting performance of various linear, GARCH, EGARCH, GJR and neural network models of volatility are evaluated and compared. The models are also augmented by the addition of a measure of lagged volume to form more general ex-ante forecasting models. The results indicate that augmenting models of volatility with measures of lagged volume leads only to very modest improvements, if any, in forecasting performance.

Linkages between property asset returns and interest rates: evidence for the UK

This paper considers the effect of short- and long-term interest rates, and interest rate spreads upon real estate index returns in the UK. Using Johansen's vector autoregressive framework, it is found that the real estate index cointegrates with the term spread, but not with the short or long rates themselves. Granger causality tests indicate that movements in short term interest rates and the spread cause movements in the returns series. However, decomposition of the forecast error variances from VAR models indicate that changes in these variables can only explain a small proportion of the overall variability of the returns, and that the effect has fully worked through after two months. The results suggest that these financial variables could potentially be used as leading indicators for real estate markets, with corresponding implications for return predictability.

The effect of asymmetries on stock index return value-at-risk estimates

It is widely accepted that equity return volatility increases more following negative shocks rather than positive shocks. However, much of value-at-risk (VaR) analysis relies on the assumption that returns are normally distributed (a symmetric distribution). This article considers the effect of asymmetries on the evaluation and accuracy of VaR by comparing estimates based on various models.

Time series multistep-ahead predictability estimation and ranking

A predictability index was defined as the ratio of the variance of the optimal prediction to the variance of the original time series by Granger and Anderson (1976) and Bhansali (1989). A new simplified algorithm for estimating the predictability index is introduced and the new estimator is shown to be a simple and effective tool in applications of predictability ranking and as an aid in the preliminary analysis of time series. The relationship between the predictability index and the position of the poles and lag p of a time series which can be modelled as an AR(p) model are also investigated. The effectiveness of the algorithm is demonstrated using numerical examples including an application to stock prices.

International evidence on the predictability of returns to securitized real estate assets: econometric models versus neural networks

The performance of various statistical models and commonly used financial indicators for forecasting securitised real estate returns are examined for five European countries: the UK, Belgium, the Netherlands, France and Italy. Within a VAR framework, it is demonstrated that the gilt-equity yield ratio is in most cases a better predictor of securitized returns than the term structure or the dividend yield. In particular, investors should consider in their real estate return models the predictability of the gilt-equity yield ratio in Belgium, the Netherlands and France, and the term structure of interest rates in France. Predictions obtained from the VAR and univariate time-series models are compared with the predictions of an artificial neural network model. It is found that, whilst no single model is universally superior across all series, accuracy measures and horizons considered, the neural network model is generally able to offer the most accurate predictions for 1-month horizons. For quarterly and half-yearly forecasts, the random walk with a drift is the most successful for the UK, Belgian and Dutch returns and the neural network for French and Italian returns. Although this study underscores market context and forecast horizon as parameters relevant to the choice of the forecast model, it strongly indicates that analysts should exploit the potential of neural networks and assess more fully their forecast performance against more traditional models.

Seasonality in Southeast Asian stock markets: some new evidence on day-of-the-week effects

This paper examines the evidence for a day-of-the-week effect in five Southeast Asian stock markets: South Korea, Malaysia, the Philippines, Taiwan and Thailand. Findings indicate significant seasonality for three of the five markets. Market risk, proxied by the return on the FTA World Price Index, is not sufficient to explain this calendar anomaly. Although an extension of the risk-return equation to incorporate interactive seasonal dummy variables can explain some significant day-of-the-week effects, market risk alone appears insufficient to characterize this phenomenon.

A note on atmospheric predictability

Using the method of Lorenz (1982), we have estimated the predictability of a recent version of the European Center for Medium-Range Weather Forecasting (ECMWF) model using two different estimates of the initial error corresponding to 6- and 24-hr forecast errors, respectively. For a 6-hr forecast error of the extratropical 500-hPa geopotential height field, a potential increase in forecast skill by more than 3 d is suggested, indicating a further increase in predictability by another 1.5 d compared to the use of a 24-hr forecast error. This is due to a smaller initial error and to an initial error reduction resulting in a smaller averaged growth rate for the whole 7-d forecast. A similar assessment for the tropics using the wind vector fields at 850 and 250 hPa suggests a huge potential improvement with a 7-d forecast providing the same skill as a 1-d forecast now. A contributing factor to the increase in the estimate of predictability is the apparent slow increase of error during the early part of the forecast.

The predictability of extratropical storm tracks and the sensitivity of their prediction to the observing system

A new method for assessing forecast skill and predictability that involves the identification and tracking of extratropical cyclones has been developed and implemented to obtain detailed information about the prediction of cyclones that cannot be obtained from more conventional analysis methodologies. The cyclones were identified and tracked along the forecast trajectories, and statistics were generated to determine the rate at which the position and intensity of the forecasted storms diverge from the analyzed tracks as a function of forecast lead time. The results show a higher level of skill in predicting the position of extratropical cyclones than the intensity. They also show that there is potential to improve the skill in predicting the position by 1 - 1.5 days and the intensity by 2 - 3 days, via improvements to the forecast model. Further analysis shows that forecasted storms move at a slower speed than analyzed storms on average and that there is a larger error in the predicted amplitudes of intense storms than the weaker storms. The results also show that some storms can be predicted up to 3 days before they are identified as an 850-hPa vorticity center in the analyses. In general, the results show a higher level of skill in the Northern Hemisphere (NH) than the Southern Hemisphere (SH); however, the rapid growth of NH winter storms is not very well predicted. The impact that observations of different types have on the prediction of the extratropical cyclones has also been explored, using forecasts integrated from analyses that were constructed from reduced observing systems. A terrestrial, satellite, and surface-based system were investigated and the results showed that the predictive skill of the terrestrial system was superior to the satellite system in the NH. Further analysis showed that the satellite system was not very good at predicting the growth of the storms. In the SH the terrestrial system has significantly less skill than the satellite system, highlighting the dominance of satellite observations in this hemisphere. The surface system has very poor predictive skill in both hemispheres.

The role of the basic state in the ENSO-monsoon relationship and implications for predictability

The impact of systematic model errors on a coupled simulation of the Asian Summer monsoon and its interannual variability is studied. Although the mean monsoon climate is reasonably well captured, systematic errors in the equatorial Pacific mean that the monsoon-ENSO teleconnection is rather poorly represented in the GCM. A system of ocean-surface heat flux adjustments is implemented in the tropical Pacific and Indian Oceans in order to reduce the systematic biases. In this version of the GCM, the monsoon-ENSO teleconnection is better simulated, particularly the lag-lead relationships in which weak monsoons precede the peak of El Nino. In part this is related to changes in the characteristics of El Nino, which has a more realistic evolution in its developing phase. A stronger ENSO amplitude in the new model version also feeds back to further strengthen the teleconnection. These results have important implications for the use of coupled models for seasonal prediction of systems such as the monsoon, and suggest that some form of flux correction may have significant benefits where model systematic error compromises important teleconnections and modes of interannual variability.

Data assimilation for morphodynamic prediction and predictability

This paper gives an overview of the project Changing Coastlines: data assimilation for morphodynamic prediction and predictability. This project is investigating whether data assimilation could be used to improve coastal morphodynamic modeling. The concept of data assimilation is described, and the benefits that data assimilation could bring to coastal morphodynamic modeling are discussed. Application of data assimilation in a simple 1D morphodynamic model is presented. This shows that data assimilation can be used to improve the current state of the model bathymetry, and to tune the model parameter. We now intend to implement these ideas in a 2D morphodynamic model, for two study sites. The logistics of this are considered, including model design and implementation, and data requirement issues. We envisage that this work could provide a means for maintaining up-to-date information on coastal bathymetry, without the need for costly survey campaigns. This would be useful for a range of coastal management issues, including coastal flood forecasting.

Potential predictability of rapid changes in the Atlantic meridional overturning circulation

We explore the potential predictability of rapid changes in the Atlantic meridional overturning circulation (MOC) using a coupled global climate model (HadCM3). Rapid changes in the temperature and salinity of surface water in the Nordic Seas, and the flow of dense water through Denmark Strait, are found to be precursors to rapid changes in the model's MOC, with a lead time of around 10 years. The mechanism proposed to explain this potential predictability relies on the development of density anomalies in the Nordic Seas which propagate through Denmark Strait and along the deep western boundary current, affecting the overturning. These rapid changes in the MOC have significant, and widespread, climate impacts which are potentially predictable a few years ahead. Whilst the flow through Denmark Strait is too strong in HadCM3, the presence of such potential predictability motivates the monitoring of water properties in the Nordic Seas and Denmark Strait.