Financial Volatility and Economic Activity
AbstractDoes 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.
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Bibliographic InfoPaper provided by Financial Markets Group in its series FMG Discussion Papers with number dp642.
Date of creation: Nov 2009
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Web page: http://www.lse.ac.uk/fmg/
Other versions of this item:
- Fornari Fabio & Mele Antonio, 2013. "Financial Volatility and Economic Activity," Journal of Financial Management, Markets and Institutions, Società editrice il Mulino, issue 2, pages 155-198, December.
- F3 - International Economics - - International Finance
- G3 - Financial Economics - - Corporate Finance and Governance
- J1 - Labor and Demographic Economics - - Demographic Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-01-23 (All new papers)
- NEP-BEC-2010-01-23 (Business Economics)
- NEP-FDG-2010-01-23 (Financial Development & Growth)
- NEP-FMK-2010-01-23 (Financial Markets)
- NEP-MAC-2010-01-23 (Macroeconomics)
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