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Asset prices and economic fluctuations: The implications of stochastic volatility

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  • Chen, Junping
  • Xiong, Xiong
  • Zhu, Jie
  • Zhu, Xiaoneng

Abstract

This paper investigates whether the multi-factor stochastic volatility of stock returns is related to economic fluctuations and affects asset prices. We address these issues in a dynamic Fama-French three-factor volatility model framework. Consistent with the ICAPM with stochastic volatility (Campbell et al., 2017), we find that the conditional volatility of the size and value factors is significantly related to economic uncertainty. These volatilities are also significant pricing factors. The out-of-sample forecasting analysis further reveals that the conditional volatility can predict stock returns and deliver economic gain in asset allocation. Our analysis sharpens the understanding on the link between the stock market and economic fundamentals.

Suggested Citation

  • Chen, Junping & Xiong, Xiong & Zhu, Jie & Zhu, Xiaoneng, 2017. "Asset prices and economic fluctuations: The implications of stochastic volatility," Economic Modelling, Elsevier, vol. 64(C), pages 128-140.
    • Handle: RePEc:eee:ecmode:v:64:y:2017:i:c:p:128-140
    DOI: 10.1016/j.econmod.2017.03.017
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    More about this item

    Keywords

    Economic fluctuations; Dynamic Fama-French factors; Stochastic volatility; International stock markets; Predictability;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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