Forecasting Realized Volatility With Kernel Ridge Regression

Abstract

This paper explores a common machine learning tool, the kernel ridge regression, as applied to financial volatility forecasting. It is shown that kernel ridge provides reliable forecast improvements to both a linear specification, and a fitted nonlinear specification which represents well known empirical features from volatility modeling. Therefore, the kernel ridge specification is still finding some nonlinear improvements that are not part of the usual volatility modeling toolkit. Various diagnostics show it to be a reliable and useful tool. Finally, the results are applied in a dynamic volatility control trading strategy. The kernel ridge results again show improvements over linear modeling tools when applied to building a dynamic strategy.