Volatility (Dis)Connect in International Markets

40 Pages Posted: 28 Jan 2022

See all articles by Ric Colacito

Ric Colacito

University of North Carolina Kenan-Flagler Business School; NBER

Mariano (Max) Massimiliano Croce

Finance Department, Bocconi University; Centre for Economic Policy Research (CEPR)

Yang Liu

The University of Hong Kong - Faculty of Business and Economics

Ivan Shaliastovich

University of Wisconsin - Madison

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2021

Abstract

Lack of co-movement between consumption growth differentials and real exchange rates is a traditional indicator of a disconnect of foreign exchange markets from economic fundamentals (Backus-Smith 1993 anomaly). We present novel evidence for the (dis)connect between the volatilities, as opposed to the levels, of these variables. The volatility correlations are below one, but they are larger than the level correlations. In the cross-section of countries, the volatility disconnect weakens for countries with low amount of expected growth risk and high amount of volatility risk. We provide an explanation of our empirical findings based on international risk-sharing of both expected growth and volatility news shocks.

Keywords: Volatility risk, foreign exchange disconnect, risk sharing

JEL Classification: C62, F31, G12

Suggested Citation

Colacito, Riccardo and Croce, Mariano Massimiliano and Liu, Yang and Shaliastovich, Ivan, Volatility (Dis)Connect in International Markets (September 1, 2021). Available at SSRN: https://ssrn.com/abstract=4015823 or http://dx.doi.org/10.2139/ssrn.4015823

Riccardo Colacito

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

HOME PAGE: http://drric.web.unc.edu/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Mariano Massimiliano Croce

Finance Department, Bocconi University ( email )

Via Sarfatti, 25
Milan, MI 20136
Italy

HOME PAGE: http://sites.google.com/view/mmcroce/home

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Yang Liu (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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