Macroeconomic Determinants of Stock Market Volatility and Volatility Risk-Premiums
70 Pages Posted: 14 Feb 2012
Date Written: April 22, 2012
How does stock market volatility relate to the business cycle? We develop, and estimate, a no-arbitrage model to study the cyclical properties of stock volatility and the risk-premiums the market requires to bear the risk of uctuations in this volatility. The level of stock market volatility cannot be explained by the mere existence of the business cycle. Rather, it relates to the presence of some unobserved factor. At the same time, our model predicts that such an unobservable factor cannot explain the ups and downs stock volatility experiences over time - the "volatility of volatility." Instead, the volatility of stock volatility relates to the business cycle. Finally, volatility risk-premiums are strongly countercyclical, even more so than stock volatility, and are partially responsible for the large swings in the VIX index occurred during the 2007-2009 subprime crisis, which our model does capture in out-of-sample experiments.
Keywords: Aggregate stock market volatility, volatility risk-premiums, volatility of volatility, business cycle, no-arbitrage restrictions, simulation-based inference
JEL Classification: C15, C32, E37, E44, G13, G17
Suggested Citation: Suggested Citation