Realized volatility and absolute return volatility: a comparison indicating market risk

Area of Science:

• Quantitative Finance
• Financial Econometrics
• Risk Management

Background:

• Accurate volatility measurement is crucial for financial risk management and investment strategies.
• Realized volatility (RV) and absolute return volatility (ARV) are two prominent nonparametric methods.
• RV is favored in finance, while ARV is preferred by econophysicists.

Purpose of the Study:

• To compare the memory and clustering features of RV and ARV.
• To evaluate the predictive power and risk indication capabilities of both volatility measures.
• To provide empirical guidelines for researchers and market participants on choosing appropriate volatility metrics.

Main Methods:

• Nonparametric measurement of financial market volatility.
• Analysis of memory and clustering properties for RV and ARV.
• Empirical comparison of short-term predictive power and risk sensitivity.

Main Results:

• Both realized volatility and absolute return volatility exhibit strong predictive capabilities.
• Realized volatility demonstrates superior short-term performance for predicting near-future market behavior.
• Absolute return volatility is computationally simpler and offers comparable risk indication sensitivity to realized volatility.

Conclusions:

• Both RV and ARV are valuable tools in financial risk management.
• The choice between RV and ARV depends on specific application needs (short-term prediction vs. ease of calculation).
• This study offers a clear comparison of strengths and weaknesses to guide practitioners and academics.