Spillover-Informed Network Architecture for Global Volatility Forecasting

2026-08-14

AI Summary

This study addresses the challenge of inaccurate global stock market forecasting caused by cross-border volatility spillovers by proposing a Spillover-Aware Network architecture. By integrating cross-market connectivity metrics, such as the Diebold-Yilmaz index, the model enhances predictive accuracy through explicit spillover modeling. Empirical results demonstrate that the proposed framework reduces out-of-sample QLIKE loss by 13% relative to benchmarks, with improvements reaching 21% during crisis periods. Furthermore, Model Confidence Set tests confirm its statistical superiority over traditional methods, yielding an annualized investment premium exceeding 322 basis points. These findings underscore the critical role of data-driven spillover networks in improving volatility forecast precision, strengthening crisis resilience, and delivering substantial economic value for risk management applications.

Abstract

Spillover of volatility shocks across borders during turbulent periods makes accurate equity market volatility forecasts especially critical for risk management, derivatives pricing, and regulatory capital. In this paper, we examine whether volatility forecasts improve when models incorporate information on how markets are connected, and whether the choice of connection measure matters. Using daily data on 29 equity indices from every major region over 2015-2025, we let each market's forecast draw on the recent volatility of the markets linked to it, with the strength of each link set either by geography, return correlation, or the Diebold-Yilmaz (DY) spillover network estimated from the data. The spillover-informed forecasting model achieved an approximately 13\% reduction in out-of-sample QLIKE loss relative to the standard Heterogeneous AutoRegressive benchmark ($p<0.001$) and attained the highest model confidence set $p$-value among the models considered. Several benchmark models that do not explicitly incorporate cross-market structure were excluded from the 90\% model confidence set. The greatest improvements were observed during periods of elevated market stress: the COVID-19 crash, the Russian invasion of Ukraine, and the $2025$ US tariff shock, spillover-informed forecasts achieved approximately 21\% lower QLIKE loss than an otherwise identical network-blind model ($p = 0.018$), with no significant performance loss during calm periods. The advantage is economically material: a volatility-targeting investor would pay $322$-$373$ basis points per year, net of transaction costs, for spillover-informed forecasts, versus an insignificant $85$-$102$ basis point for the alternatives. Finally, when the model is left to infer connections on its own, it recovers the DY network from the forecast objective alone (permutation $p=0.0005$).

Problem

• Volatility Forecasting
• Spillover Effects
• Cross-market Connectivity
• Global Equity Markets
• Risk Management

Innovation

• Spillover-Informed Network
• Diebold-Yilmaz Spillover Network
• Global Volatility Forecasting
• Market Stress Resilience
• Network Structure Learning