Forecasting the volatility of Chinese stock market: An international volatility index

摘要

To forecast the volatility of Chinese stock market, we use information from 28 international markets rather than relying on the Chinese market alone. A common factor, which we call the international volatility index, is constructed by the first principal component of all the 28 cross-national stock market volatilities. We then add the international volatility index into the prevailing heterogeneous autoregressive model of realized volatility (HAR-RV). The in-sample estimation results show that the impact of this common index on future Chinese market volatility is statistically significant and positive. More importantly, the out-of-sample forecasting results suggest that our proposed model outperforms competing models including the HAR-RV, kitchen sink model, and combination approaches. The results are similar when we use a wide range of robustness checks. Furthermore, the international volatility index also yields the highest economic value from an asset allocation perspective.