Business Cycle and Stock Market Volatility: Are They Related?

Abstract

We investigate the latent volatility structures of the fluctuations in the US business cycle and stock market valuations. The technical novelty of this work lies in the estimation of a Markov-switching stochastic-volatility model that allows for Bayesian sequential evaluation on both the parameters and the latent variables. Our findings point to macroeconomic and financial indicators following common volatility patterns,with a switch to lower variability occurring in the latter part of our sample in business cycle first and then in stock market variables.

Keywords: Markov Switching, Stochastic Volatility, Business Cycle, Equity Markets, Particle Filter

JEL Classification: C11, C15, C22, C63, G10, E32, E44