What Does Financial Volatility Tell Us About Macroeconomic Fluctuations?

33 Pages Posted: 4 May 2012

See all articles by Marcelle Chauvet

Marcelle Chauvet

University of California Riverside

Zeynep Senyuz

Board of Governors of the Federal Reserve System

Emre Yoldas

Federal Reserve Board

Multiple version iconThere are 3 versions of this paper

Date Written: February 6, 2012

Abstract

This paper provides an extensive analysis of the predictive ability of financial volatility measures for economic activity. We construct monthly measures of aggregated and industry-level stock volatility, and bond market volatility from daily returns. We model log financial volatility as composed of a long-run component that is common across all series, and a short-run component. If volatility has components, volatility proxies are characterized by large measurement error, which veils analysis of their fundamental information and relationship with the economy. We find that there are substantial gains from using the long term component of the volatility measures for linearly projecting future economic activity, as well as for forecasting business cycle turning points. When we allow for asymmetry in the long-run volatility component, we find that it provides early signals of upcoming recessions. In a real-time out-of-sample analysis of the last recession, we find that these signals are concomitant with the first signs of distress in the financial markets due to problems in the housing sector around mid-2007 and the implied chronology is consistent with the crisis timeline.

Keywords: Realized Volatility, Business Cycles, Forecasting, Probit model, Dynamic Factor Model, Markov Switching

JEL Classification: C32, E32, E44

Suggested Citation

Chauvet, Marcelle and Senyuz, Zeynep and Yoldas, Emre, What Does Financial Volatility Tell Us About Macroeconomic Fluctuations? (February 6, 2012). FEDS Working Paper No. 2012-09. Available at SSRN: https://ssrn.com/abstract=2050998 or http://dx.doi.org/10.2139/ssrn.2050998

Marcelle Chauvet

University of California Riverside ( email )

900 University Avenue
4136 Sproul Hall
Riverside, CA 92521
United States
(951) 827-1587 (Phone)

HOME PAGE: http://https://sites.google.com/site/marcellechauvet/

Zeynep Senyuz

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Emre Yoldas (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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