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Stock Market Volatility and Macroeconomic Fundamentals

Author

Listed:
  • Robert F. Engle

    (New York University)

  • Eric Ghysels

    (University of North Carolina at Chapel Hill)

  • Bumjean Sohn

    (Korea University Business School)

Abstract

We revisit the relation between stock market volatility and macroeconomic activity using a new class of component models that distinguish short-run from long-run movements. We formulate models with the long-term component driven by inflation and industrial production growth that are in terms of pseudo out-of-sample prediction for horizons of one quarter at par or outperform more traditional time series volatility models at longer horizons. Hence, imputing economic fundamentals into volatility models pays off in terms of long-horizon forecasting. We also find that macroeconomic fundamentals play a significant role even at short horizons. © 2013 The President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Suggested Citation

  • Robert F. Engle & Eric Ghysels & Bumjean Sohn, 2013. "Stock Market Volatility and Macroeconomic Fundamentals," The Review of Economics and Statistics, MIT Press, vol. 95(3), pages 776-797, July.
  • Handle: RePEc:tpr:restat:v:95:y:2013:i:3:p:776-797
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    Keywords

    stock market volatility; macroeconomic activity;

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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