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Financial market volatility, macroeconomic fundamentals and investor sentiment

Ching-Wai (Jeremy) Chiu, Richard Harris (), Evarist Stoja () and Michael Chin ()
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Evarist Stoja: University of Bristol
Michael Chin: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH

No 608, Bank of England working papers from Bank of England

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.

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)
New Economics Papers: this item is included in nep-mac
Date: 2016-08-16
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