The Effect of Uncertainty on Volatility and Correlation

38 Pages Posted: 22 Mar 2018 Last revised: 18 May 2023

See all articles by Hossein Asgharian

Hossein Asgharian

Lund University - Department of Economics; Knut Wicksell Centre for Financial Studies

Charlotte Christiansen

Aarhus University - CREATES

Ai Jun Hou

Stockholm University

Date Written: May 6, 2019

Abstract

In this study, we use an extension of the heterogeneous autoregressive model to investigate the influence of time-varying risk aversion and macroeconomic, financial, and economic policy uncertainty measures on stock market volatility and correlation. Based on the findings, there is a stronger predictive ability of these variables at the monthly frequency than at the daily frequency. We also highlight the importance of risk aversion, which, alongside fundamental factors, reflects investor sentiment in predicting stock market volatility. Meanwhile, although uncertainty variables, such as economic uncertainty and financial uncertainty, are important, the widely used variable, economic policy uncertainty, is not helpful for predicting stock market volatility. Moreover, there is evidence of higher economic value and reduced portfolio risk when including risk aversion and economic uncertainty in international portfolio analysis.

Keywords: economic uncertainty; HAR model; international-portfolio analysis; stock market correlation; stock market volatility

JEL Classification: C32; G11; G15; G17

Suggested Citation

Asgharian, Hossein and Christiansen, Charlotte and Hou, Ai Jun, The Effect of Uncertainty on Volatility and Correlation (May 6, 2019). Available at SSRN: https://ssrn.com/abstract=3146924 or http://dx.doi.org/10.2139/ssrn.3146924

Hossein Asgharian

Lund University - Department of Economics; Knut Wicksell Centre for Financial Studies ( email )

P.O. Box 7082
S-220 07 Lund
Sweden
046-222-86-87 (Phone)

Charlotte Christiansen (Contact Author)

Aarhus University - CREATES ( email )

Fuglesangs Alle 4
Aarhus V, DK 8210
Denmark

Ai Jun Hou

Stockholm University ( email )

Universitetsvägen 10
Stockholm, Stockholm SE-106 91
Sweden

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