Customer Reviews

A Practical Guide to Forecasting Financial Market Volatility (The Wiley Finance Series)

5 star:		(0)
4 star:		(0)
3 star:		(1)
2 star:		(0)
1 star:		(0)

 

 

As it regularly happens to titles in the Wiley Finance series, the title is misleading. This is not a practical guide to forcasting volatility but a review of the academic studies comparing the forcating power of various ARCH, GARCH, FARCH time series methods.

The author is a business school professor in the U.K., who is well respected in the time-series community. Two years before the publication of the current volume she co-authored a review (first star) on the same topics with one of the Nobel laureates on the subject. Assuming that the book is a hardcover version of the same review, this lends some authorativeness to its contents (second star).

To the reviewer the real practical value of the book and of the underlying study is in its following two findings (third and fourth stars).

1. Every self-respecting inventor of a new ARCH, GARCH, FARCH method also publishes a separate academic study showing that his/her method is superior to any of the other ones. Hence time can be saved for better use by ignoring all these studies.

2. Continuous-time stochastic volatility models based on stochastic differential equations consistently outperform discretely sampled time-series models that are based on daily observations. Hence more time can be saved for better use by ignoring the entity of this particularly voluminous body of literature. (The book doesn't cover realized volatility based on high frequency data. Hence the above conclusion doesn't apply to this body of work.)

Having reached the zenith of four stars, one star is subtracted for the author trying to impress her readers with stuff that is clearly over her head. It is a typical fallacy of business school professors, that they try to look to be mathematicians and make fool of themselves in the process.

Here is an example. Chapter 9 of the book is devoted to Option Pricing with Stochastic Volatility and covers the Heston model (Sec.9.1-9.4). Then in Sec.9.5, which attempts to explain the meaning of the Market Price of Volatility, the volatility process is unexpectedly changed form CIR to OU. The justification given is that volatility must be positive. Well, the CIR process was positive, the OU isn't (first flashing warning sign). Then follow seven pages of formulas closely resembling the same derivation by Fouque, Papanicoulau and Sircar (FPS), albeit with different notation. And that's where the devil hits. At a particular point in the derivation an "arbitrary function" appears. The author names it "f", in accordance with how "arbitary functions" are usually denoted in math classes. Than she cut-and-pastes in the final formula from FPS, which also contains the symbol "f". Unfortunately FPS uses "f" to denote a totally different function that doesn't even show up in Ms.Poon's book. In short, Sec.9.5 makes no sense.

Final verdict: 3 stars.