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Financial Volatility and Economic Activity

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  • Antonio Mele

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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.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp642.

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Date of creation: Nov 2009
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Handle: RePEc:fmg:fmgdps:dp642

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Cited by:
  1. Marcelle Chauvet & Zeynep Senyuz & Emre Yoldas, 2013. "What does financial volatility tell us about macroeconomic fluctuations?," Finance and Economics Discussion Series 2013-61, Board of Governors of the Federal Reserve System (U.S.).
  2. Charlotte Christiansen & Maik Schmeling & Andreas Schrimpf, 2012. "A Comprehensive Look at Financial Volatility Prediction by Economic Variables," BIS Working Papers 374, Bank for International Settlements.
  3. Chris Florakis & Gianluigi Giorgioni & Alexandros Kostakis & Costas Milas, 2012. "The Impact of Stock Market Illiquidity on Real UK GDP Growth," Working Paper Series 65_12, The Rimini Centre for Economic Analysis.
  4. Todd Clark & Michael W. McCracken, 2011. "Tests of equal forecast accuracy for overlapping models," Working Paper 1121, Federal Reserve Bank of Cleveland.
  5. Nieto, Belén & Rubio, Gonzalo, 2011. "The volatility of consumption-based stochastic discount factors and economic cycles," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2197-2216, September.
  6. de Bondt, Gabe & Maddaloni, Angela & Peydró, José-Luis & Scopel, Silvia, 2010. "The euro area Bank Lending Survey matters: empirical evidence for credit and output growth," Working Paper Series 1160, European Central Bank.
  7. di Mauro, Filippo & Fornari, Fabio & Mannucci, Dario, 2011. "Stock market firm-level information and real economic activity," Working Paper Series 1366, European Central Bank.
  8. Mario Meichle & Angelo Ranaldo & Attilio Zanetti, 2011. "Do financial variables help predict the state of the business cycle in small open economies? Evidence from Switzerland," Financial Markets and Portfolio Management, Springer, vol. 25(4), pages 435-453, December.
  9. Mario Jovanovic, 2011. "Does Monetary Policy Affect Stock Market Uncertainty? – Empirical Evidence from the United States," Ruhr Economic Papers 0240, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  10. Marco Lombardi & Raphael A. Espinoza & Fabio Fornari, 2009. "The Role of Financial Variables in Predicting Economic Activity in the Euro Area," IMF Working Papers 09/241, International Monetary Fund.
  11. Choi, Sangyup, 2013. "Are the effects of Bloom’s uncertainty shocks robust?," Economics Letters, Elsevier, vol. 119(2), pages 216-220.

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