Scaling by the square-root-of-time rule: An empirical investigation using five market indexes

Authors

James Cameron, University of Wollongong
Chandra M. Gulati, University of WollongongFollow
Yan-Xia Lin, University of WollongongFollow

RIS ID

111110

Publication Details

Cameron, J., Gulati, C. & Lin, Y. (2016). Scaling by the square-root-of-time rule: An empirical investigation using five market indexes. Journal of Risk, 19 (2), 61-80.

Abstract

The value of the theoretical constant used to scale daily volatility to both a five-day volatility estimate and a ten-day volatility estimate is compared with empirical estimates using a volatility modeling framework. Five composite stock indexes are analyzed to determine the different behaviors of scaling across markets. Both developed and emerging markets are considered, to provide additional detail to the comparisons. The results provided are considered in a value-at-risk application. While using the square-root-of-time rule on a weekly or ten-day basis is appropriate in certain cases, for time series with a linear dependence component the rule can drastically err from observed volatility levels. It is demonstrated that there are potential hazards when using the square-root-of-time rule for risk or compliance purposes.