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Asset prices and economic fluctuations: The implications of stochastic volatility

Junping Chen, Xiong Xiong, Jie Zhu and Xiaoneng Zhu

Economic Modelling, 2017, vol. 64, issue C, 128-140

Abstract: This paper investigates whether the multi-factor stochastic volatility of stock returns is related to economic fluctuations and affects asset prices. We address these issues in a dynamic Fama-French three-factor volatility model framework. Consistent with the ICAPM with stochastic volatility (Campbell et al., 2017), we find that the conditional volatility of the size and value factors is significantly related to economic uncertainty. These volatilities are also significant pricing factors. The out-of-sample forecasting analysis further reveals that the conditional volatility can predict stock returns and deliver economic gain in asset allocation. Our analysis sharpens the understanding on the link between the stock market and economic fundamentals.

Keywords: Economic fluctuations; Dynamic Fama-French factors; Stochastic volatility; International stock markets; Predictability (search for similar items in EconPapers)
JEL-codes: C1 C58 G12 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:ecmode:v:64:y:2017:i:c:p:128-140