Abstract
We perform an extensive investigation of different specifications of the BEKK-type multivariate volatility models for a moderate number of assets, focusing on how the degree of parametrization affects forecasting performance. Because the unrestricted specification may be too generously parameterized, often one imposes restrictions on coefficient matrices constraining them to have a diagonal or even scalar structure.
We frame all three model variations (full, diagonal, scalar) as special cases of a ridge-type regularized estimator, where the off-diagonal elements are shrunk towards zero and the diagonal elements are shrunk towards homogeneity. Our forecasting experiments with BEKK-type Conditional Autoregressive Wishart model for realized volatility confirm the superiority of the more parsimonious scalar and diagonal model variations.
Even though sometimes a moderate degree of regularization of the diagonal and off-diagonal parameters may be beneficial for forecasting performance, it does not regularly lead to tangible performance improvements irrespective of how precise is tuning of regularization intensity. Additionally, our results highlight the crucial importance of frequent model re-estimation in improving the forecast precision, and, perhaps paradoxically, a slight advantage of shorter estimation windows compared to longer windows.