Forecasting Market Fear: the roles of policy uncertainty and geopolitical Risk

This paper examines the predictive power of Economic Policy Uncertainty (EPU) and Geopolitical Risk (GPR) indices on market fear, as reflected by implied volatility indices across various assets and regions. A GARCH-MIDAS model is employed to analyse how low-frequency economic policy and geopolitical risks affect high-frequency market fear indices, using realized volatility as a benchmark. The study incorporates global, U.S., and Russia-based EPU, alongside multiple GPR variants, to assess their influence on implied volatility across stocks, commodities, and IT equities. Our results show that GARCH-MIDAS models incorporating external uncertainty indices significantly outperform the conventional GARCH-MIDAS model based on realized volatility alone, with particularly strong performance observed for global and U.S. uncertainty measures across multiple forecast horizons. These results highlight the importance of monitoring external uncertainties to support pre-emptive policy measures and to guide investors in integrating such insights into risk assessment models for improved volatility management.