Financial volatility and economic activity

Fabio Fornari and Antonio Mele

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Does capital markets uncertainty affect the business cycle? We find that financial volatility predicts 30% of post-war economic activity in the United States, and that during the Great Moderation, aggregate stock market volatility explains, alone, up to 55% of real growth. In out- of-sample tests, we find that stock volatility helps predict turning points over and above traditional financial variables such as credit or term spreads, and other leading indicators. Combining stock volatility and the term spread leads to a proxy for (i) aggregate risk, (ii) risk-premiums and (iii) monetary policy, which is found to track, and anticipate, the business cycle. At the heart of our analysis is a notion of volatility based on a slowly changing measure of return variability. This volatility is designed to capture long-run uncertainty in capital markets, and is particularly successful at explaining trends in the economic activity at horizons of six months and one year.

JEL-codes: G00 N12 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2009-11-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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http://eprints.lse.ac.uk/29309/ Open access version. (application/pdf)

Related works:
Journal Article: Financial Volatility and Economic Activity (2013)
Working Paper: Financial Volatility and Economic Activity (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:29309

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