Covariance matrix forecasting using support vector regression

Abstract

Support vector regression is a promising method for time-series prediction, as it has good generalisability and an overall stable behaviour. Recent studies have shown that it can describe the dynamic characteristics of financial processes and make more accurate forecasts than other machine learning techniques. The first main contribution of this paper is to propose a methodology for dynamic modelling and forecasting covariance matrices based on support vector regression using the Cholesky decomposition. The procedure is applied to range-based covariance matrices of returns, which are estimated on the basis of low and high prices. Such prices are most often available with closing prices for many financial series and contain more information about volatility and relationships between returns. The methodology guarantees the positive definiteness of the forecasted covariance matrices and is flexible, as it can be applied to different dependence patterns. The second contribution of the paper is to show with an example of the exchange rates from the forex market that the covariance matrix forecasts calculated using the proposed approach are more accurate than the forecasts from the benchmark dynamic conditional correlation model. The advantage of the suggested procedure is higher during turbulent periods, i.e., when forecasting is the most difficult and accurate forecasts matter most.