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What does financial volatility tell us about macroeconomic fluctuations?

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  • Chauvet, Marcelle
  • Senyuz, Zeynep
  • Yoldas, Emre

Abstract

This paper provides an extensive analysis of the predictive ability of financial volatility measures for economic activity. We construct monthly measures of aggregated and industry-level stock volatility, and bond market volatility from daily returns. We model log financial volatility as composed of a long-run component that is common across all series, and a short-run component. If volatility has components, volatility proxies are characterized by large measurement error, which veils analysis of their fundamental information and relationship with the economy. We find that there are substantial gains from using the long term component of the volatility measures for linearly projecting future economic activity, as well as for forecasting business cycle turning points. When we allow for asymmetry in the long-run volatility component, we find that it provides early signals of upcoming recessions. In a real-time out-of-sample analysis of the last recession, we find that these signals are concomitant with the first signs of distress in the financial markets due to problems in the housing sector around mid-2007 and the implied chronology is consistent with the crisis timeline.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34104.

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Date of creation: Oct 2010
Date of revision: Jun 2011
Handle: RePEc:pra:mprapa:34104

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Keywords: Realized Volatility; Business Cycles; Forecasting; Dynamic Factor Models; Markov Switching;

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References

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Cited by:
  1. Charlotte Christiansen & Maik Schmeling & Andreas Schrimpf, 2012. "A comprehensive look at financial volatility prediction by economic variables," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 27(6), pages 956-977, 09.
  2. Ferrara, L. & Marsilli, C. & Ortega, J-P., 2013. "Forecasting growth during the Great Recession: is financial volatility the missing ingredient?," Working papers, Banque de France 454, Banque de France.

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