Forecasting yield volatility, Financial Management

There are several methods available to forecast yield volatility. But before that, let us look into the calculation of forecasted standard deviation.

Assume that a trader wants to forecast volatility at the end of 07/08/2007, by using the 20 most recent days of trading and update the forecast at the end of each trading day. To calculate these, the trader can calculate a 20-day moving average of the daily percentage yield change.

Still now it has been assumed that the moving average is an appropriate value to use for the expected value of the change in yield. But, some experts view that it would be more appropriate to assume the expected value of the change in yield to be zero. In eq. (1) by substituting zeros in place of moving average X, we get

         Variance =  380_forecasting yield volatility.png                                                                                       ...Eq (2) 

An equal weightage is assigned to all observations by the daily standard deviation given by equation 2. Therefore, a weightage of 20% for each day is given if the trader is calculating volatility based on the most recent 20 days of trading.

Greater weightage is given to recent movements in the yield or price while determining volatility, and less weightage is given to the observations that are farther in the past. Revising equation 2 to include the weightages we get,

         Variance =  1498_forecasting yield volatility1.png                                                                                        ...Eq. (3)

Wt is the weight assigned to the observations t. The sum of all the weights assigned to the observation will be equal to 1.

A time series characteristic of financial assets suggests that a high volatility period is followed by a high volatility period and a low volatility period is followed by a low volatility period. From this observation, we can tell that the recent past volatility influences current volatility. This time series property of volatility can be estimated with the help of statistical models like autoregressive conditional heteroskedasticity.

Posted Date: 9/10/2012 3:46:53 AM | Location : United States



Your posts are moderated
Related Questions
Basic Assumptions of Cost of Capital The Cost of Capital is a dynamic concept affected by a multiplicity of economic and firm factors and assumes the follow

how to do assignments based on these topics more specifically?

Discuss the advantages and disadvantages of the gold standard. Answer:  The benefits of the gold standard include: (I) as the supply of gold is restricted, co

You are currently an Analyst working for a finance publication firm and as part of your responsibilities; you are required to provide a monthly forecast and ana

Statement of Cash Flows A formal statement of the cash received and disbursed through an organization. The statement of cash flows is separate into three se

You have $20 to spend on high quality pens and low quality pens. High quality pens cost $5 each and low quality pens cost $2 each.    (a) Suppose that you wi

Debentures are also fixed income securities with a specified interest rate. These securities have charge over the assets of the issuer.

Brainstor ming An idea production strategy that exclusively encourages any and all alternatives while withholding any appreciation of those options.

If the EPS is Rs.5, dividend pay-out ratio is 50%, cost of equity is 20% and growth rate in the ROI is 15%. What is the value of the stock as per Gordon's Divid

What is Net Present Value? Describe please.

Role of Trustee in Pension Fund: Trustees are people in control of long-term asset allocation of a pension scheme. Whatever benchmark they set will, as we s

Municipal Securities are debt securities issued by a State, Municipality or a County in order to finance its capital expenditures. These

An asset-backed security is a type of bond or note that is based on a pool of assets, or collateralized by the cash flows from a specified pool of u

Identify and describe three types of start ups firms. Give an example of one you have dealt with. What is a business plan, what are its major components, and

For a specified IOS and MCC, how do financial managers decide that which proposed capital budgeting projects to accept, and which to reject? For a specified I