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Forecasting Long-Horizon Volatility for Strategic Asset Allocation

Mirko Cardinale, Narayan Y. Naik and Varun Sharma
The Journal of Portfolio Management Multi-Asset Special Issue 2021, 47 (4) 83-98; DOI: https://doi.org/10.3905/jpm.2021.1.212
Mirko Cardinale
is the head of investment strategy at USS Investment Management in London, UK
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Narayan Y. Naik
is a professor of finance at the London Business School in London, UK
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Varun Sharma
is a doctoral student in finance at the London Business School in London, UK
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Abstract

Long-term volatility is a key forecasting input for strategic asset allocation analysis, yet most studies on volatility models have focused on short horizons. The authors use a large sample of global equity and bond indexes since 1934 to test the predictive power of different long-horizon volatility models. Their findings suggest that the best approach to forecasting long-horizon volatility is to use a long historical window and capture both long-term mean reversion and short-term volatility clustering properties. The results show that the authors’ model specification does a better job of reducing forecasting errors than does a naïve model based on the simple extrapolation of historical volatility.

TOPICS: Portfolio construction, volatility measures, statistical methods, performance measurement

Key Findings

  • ▪ This study tests the predictive power of different long-horizon volatility models using a large sample of global equity and bond indexes since 1934.

  • ▪ The best approach to forecasting long-horizon volatility is to use a long historical window and capture both long-term mean reversion and short-term volatility clustering properties.

  • ▪ The results show that the proposed model specification does a better job of reducing forecasting errors than does a naïve model based on the simple extrapolation of historical volatility.

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Forecasting Long-Horizon Volatility for Strategic Asset Allocation
Mirko Cardinale, Narayan Y. Naik, Varun Sharma
The Journal of Portfolio Management Feb 2021, 47 (4) 83-98; DOI: 10.3905/jpm.2021.1.212

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Forecasting Long-Horizon Volatility for Strategic Asset Allocation
Mirko Cardinale, Narayan Y. Naik, Varun Sharma
The Journal of Portfolio Management Feb 2021, 47 (4) 83-98; DOI: 10.3905/jpm.2021.1.212
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