Fear, extreme fear and U.S. stock market returns

Elie Bouri, Nikola Gradojevic and Ramzi Nekhili

Physica A: Statistical Mechanics and its Applications, 2024, vol. 656, issue C

Abstract: This paper investigates the multiscale co-movement between the levels and changes in VIX and SKEW indices and the returns of the S&P 500 market indices at the aggregate and sector levels of data. By utilizing the wavelet localized multiple correlation (WLMC) method over the most recent time period (January 3, 2006 - October 26, 2023), we demonstrate that very short-term market participants, such as traders and speculators, are watchful about the combined information from the VIX and SKEW levels; while the changes in VIX and SKEW are more informative for stock returns in the medium- to long-term, which should concern the decisions of investors and portfolio managers. We also show that VIX in general exerts a more dominant influence on the S&P 500 Index returns than SKEW, but more for VIX changes than for VIX levels. The very short-run informativeness of VIX and SKEW for stock returns is markedly pronounced around the European debt crisis (2012) and the COVID-19 meltdown (2020). The stock sector analysis reveals that defensive sectors are sensitive to the SKEW index, whereas the cyclical sectors are predominantly related to the fluctuations in the VIX index. Overall, our findings provide useful new insights into the stock market sentiment and the resulting market participants’ behavior at the market microstructure level. As such, they may be of interest not only to traders and investors, but also to financial analysts and government policy-makers in their attempts to understand the multiscale relationship between monetary policy and the stock market.

Keywords: VIX index; SKEW index; S&P 500 Index sector returns; COVID-19; Wavelets; Implied volatility (search for similar items in EconPapers)
JEL-codes: C58 G11 G15 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:656:y:2024:i:c:s0378437124007210

DOI: 10.1016/j.physa.2024.130212

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