Financial market Volatility, macroeconomic fundamentals and investor Sentiment

(Jeremy) Chiu, Ching-wai, Richard Harris, Evarist Stoja and Michael Chin

Journal of Banking & Finance, 2018, vol. 92, issue C, 130-145

Abstract: In this paper, we investigate the dynamic relationship between financial market volatility, macroeconomic fundamentals and investor sentiment, employing a two-factor model to decompose volatility into a persistent long run component and a transitory short run component. Using a structural VAR model with Bayesian sign restrictions, we show that adverse shocks to aggregate demand and supply cause an increase in the persistent component of both stock and bond market volatility, and that adverse shocks to the persistent component of either stock or bond market volatility cause a deterioration in macroeconomic fundamentals. We find no evidence of a relationship between the transitory component of volatility and macroeconomic fundamentals. Instead, we find that the transitory component is more closely associated with changes in investor sentiment. Our results are robust to a wide range of alternative specifications. Out-of-sample forecasting shows that the components of volatility can improve forecasts of macroeconomic fundamentals, and vice versa.

Keywords: Stock and bond market volatility; Two-factor volatility model; Macroeconomic fundamentals; Structural vector autoregression; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: C32 E32 E44 (search for similar items in EconPapers)
Date: 2018
References: Add references at CitEc
Citations: View citations in EconPapers (36)

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Working Paper: Financial market volatility, macroeconomic fundamentals and investor sentiment (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:92:y:2018:i:c:p:130-145

DOI: 10.1016/j.jbankfin.2018.05.003

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