Latin American Equities, Volatility Regimes, and the US Economic Policy Uncertainty

We investigate how the volatility of the iShares Latin America 40 ETF (ILF) responds to key economic and market sentiment indicators associated with economic uncertainty. Specifically, we explore the regime-dependent nature of ILF volatility in relation to Economic Policy Uncertainty (EPU), U.S. Economic Uncertainty (ECU), Global Economic Policy Uncertainty (GEPU), and implied risk, as captured by the Chicago Board Options Exchange's VIX (CBOE VIX), from 2001 to 2023. Our findings highlight that the connection between market volatility and economic/market sentiment is influenced by distinct volatility regimes. Utilizing a two-covariate GARCH-MIDAS (GM) model, a regime-switching Markov Chain (MSR) model, and quantile regressions (QR), we reveal that the impact of sentiment on realized volatility varies depending on the prevailing volatility regime, reflecting investors’ differing responses to market uncertainty. Additionally, our results show a significant linkage between ILF’s short and long-term volatility and economic uncertainty/sentiment indicators, suggesting that these factors shape ILF volatility across different market conditions and quantiles of the volatility distribution. Overall, our findings indicate that investor sentiment and economic uncertainty extend beyond their domestic origins, influencing volatility patterns in U.S., global, and Latin American markets.