Zhuo Huang, Chen Tong, Tianyi Wang , Cong Zhang
We investigate the eﬀects of economic uncertainty on the return volatility of ﬁnancial assets, including equities, bonds, foreign exchange and commodities. We use several popular measures of economic uncertainty, and find the uncertainty displays significant but heterogeneous eﬀect on ﬁnancial volatility. Economic uncertainty constructed in a data rich environment shows strong eﬀects for most ﬁnancial assets. In particular, the first principal component of the economic uncertainty measures provides a good balance of the eﬀects. The eﬀects of economic uncertainty on ﬁnancial volatility appear to be closely related to the state of the economy and are more pronounced around recession periods. Furthermore, our out-of-sample analysis shows that investors can use economic uncertainty to predict financial volatility, from both the statistical and economic perspectives.
Keywords: Economic uncertainty, Volatility forecasting, Realized volatility, Uncertainty measures
JEL: D80, E30, E44, G12, G17