Oil price volatility and macroeconomic fundamentals: A regime switching GARCH-MIDAS model

We introduce a regime switching GARCH-MIDAS model to investigate the relationships between oil price volatility and its macroeconomic fundamentals. Our model takes into account both effects of long-term macroeconomic factors and short-term structural breaks on oil volatility. The in-sample and out-o...

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Bibliographic Details
Published in:Journal of empirical finance 2017-09, Vol.43, p.130-142
Main Authors: Pan, Zhiyuan, Wang, Yudong, Wu, Chongfeng, Yin, Libo
Format: Article
Language:English
Subjects:
Crude oil
Forecasting
Mixed-frequency data sampling
Regime switching
Volatility
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Summary:We introduce a regime switching GARCH-MIDAS model to investigate the relationships between oil price volatility and its macroeconomic fundamentals. Our model takes into account both effects of long-term macroeconomic factors and short-term structural breaks on oil volatility. The in-sample and out-of-sample results show that macroeconomic fundamentals can provide useful information regarding future oil volatility beyond the historical volatility. We also find the evidence that the structural breaks cause higher degree of GARCH-implied volatility persistence. Two-regime GARCH-MIDAS models can significantly beat their single-regime counterparts in forecasting oil volatility out-of-sample. •We propose a regime switching GARCH-MIDAS model to account for structural breaks.•Oil fundamentals can provide useful information regarding future volatility.•Structural breaks cause higher degree of GARCH-implied volatility persistence.•Our two-regime models perform significantly better than the single-regime model out-of-sample.
ISSN:0927-5398
1879-1727
DOI:10.1016/j.jempfin.2017.06.005