Chapter 23 Estimating Volatilities and Correlations

In this chapter we explain how historical data can be used to produce estimates of the current and future levels of volatilities and correlations. The chapter is relevant both to the calculation of value at risk using the model-building approach and to the valuation of derivatives. When calculating value at risk, we are most interested in the current levels of volatilities and correlations because we are assessing possible changes in the value of a portfolio over a very short period of time. When valuing derivatives, forecasts of volatilities and correlations over the whole life of the derivative are usually required.

The chapter considers models with imposing names such as exponentially ...

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