Examination on the Relationship Between VHSI, HSI and Future Realized Volatility With Kalman Filter

Hang Seng Index Volatility (VHSI) is a new barometer to research the variance of Hang Seng Index (HSI). This paper first explores how VHSI changes are influenced by HSI returns dynamically. The time-varying coefficients achieved by Kalman filter indicate a negative and asymmetric contemporaneous relationship between VHSI changes and HSI returns. More importantly, we find that this asymmetric effect is stronger in Hong Kong than that in US since the investors are more sensitive to negative returns. Second, this paper studies the relationship between VHSI and the future realized volatility of HSI, and predicts the future realized volatility of HSI with Kalman filter. The empirical findings suggest that VHSI is an unbiased and efficient estimate of the future realized volatility and includes information of the future realized volatility when employing monthly data. In addition, the predication performance of Kalman filter is better than linear regression model. Copyright Eurasia Business and Economics Society 2013