The Effects of Economic Uncertainty on Financial Volatility: A Comprehensive Investigation

31 Pages Posted: 15 May 2018 Last revised: 12 May 2019

See all articles by Zhuo Huang

Zhuo Huang

National School of Development, Peking University

Chen Tong

Peking University

Tianyi Wang

University of International Business and Economics (UIBE) - School of Banking and Finance

Cong Zhang

University of Chicago - Booth School of Business

Date Written: May 7, 2018

Abstract

We investigate the effects of economic uncertainty on the return volatility of financial assets, including equities, bonds, foreign exchange and commodities. We use several popular measures of economic uncertainty, and find the uncertainty displays significant but heterogeneous effect on financial volatility. Economic uncertainty constructed in a data rich environment shows strong effects for most financial assets. In particular, the first principal component of the economic uncertainty measures provides a good balance of the effects. The effects of economic uncertainty on financial volatility appear to be closely related to the state of the economy and are more pronounced around recession periods. Furthermore, our out-of-sample analysis shows that investors can use economic uncertainty to predict financial volatility, from both the statistical and economic perspectives.

Keywords: Economic uncertainty, Volatility forecasting, Realized volatility, Uncertainty measures

JEL Classification: D80, E30, E44, G12, G17

Suggested Citation

Huang, Zhuo and Tong, Chen and Wang, Tianyi and Zhang, Cong, The Effects of Economic Uncertainty on Financial Volatility: A Comprehensive Investigation (May 7, 2018). Available at SSRN: https://ssrn.com/abstract=3174772 or http://dx.doi.org/10.2139/ssrn.3174772

Zhuo Huang (Contact Author)

National School of Development, Peking University ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

Chen Tong

Peking University ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

Tianyi Wang

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Cong Zhang

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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