# 11-125/4 (2011-09-05)

Oleg Sokolinskiy, Erasmus University Rotterdam; Dick van Dijk, Erasmus University Rotterdam
Nonlinear dependence, long memory, copulas, volatility forecasting
JEL codes:
C22, C53, C58, G17

This paper develops a novel approach to modeling and forecasting realized volatility (RV) measures based on copula functions. Copula-based time series models can capture relevant characteristics of volatility such as nonlinear dynamics and long-memory type behavior in a flexible yet parsimonious way. In an empirical application to daily volatility for S&P500 index futures, we find that the copula-based RV (C-RV) model outperforms conventional forecasting approaches for one-day ahead volatility forecasts in terms of accuracy and efficiency. Among the copula specifications considered, the Gumbel C-RV model achieves the best forecast performance, which highlights the importance of asymmetry and upper tail dependence for modeling volatility dynamics. Although we find substantial variation in the copula parameter estimates over time, conditional copulas do not improve the accuracy of volatility forecasts.