The Effects of Economic Uncertainty on Financial Volatility: A Comprehensive Investigation
31 Pages Posted: 15 May 2018 Last revised: 12 May 2019
Date Written: May 7, 2018
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
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