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Financial market volatility, macroeconomic fundamentals and investor sentiment

Author

Listed:
  • Chiu, Ching-Wai (Jeremy)

    (Bank of England)

  • Harris, Richard

    (University of Exeter)

  • Stoja, Evarist

    (University of Bristol)

  • Chin, Michael

    (Bank of England)

Abstract
In this paper, we investigate the dynamic relationship between financial market volatility, macroeconomic fundamentals and investor sentiment, employing a two-factor model to decompose volatility into a persistent long-run component and a transitory short-run component. Using a structural VAR model with Bayesian sign restrictions, we show that adverse shocks to aggregate demand and supply cause an increase in the persistent component of both stock and bond market volatility, and that adverse shocks to the persistent component of either stock or bond market volatility cause a deterioration in macroeconomic fundamentals. We find no evidence of a relationship between the transitory component of volatility and macroeconomic fundamentals. Instead, we find that the transitory component is more closely associated with changes in investor sentiment. Our results are robust to a wide range of alternative specifications.

Suggested Citation

  • Chiu, Ching-Wai (Jeremy) & Harris, Richard & Stoja, Evarist & Chin, Michael, 2016. "Financial market volatility, macroeconomic fundamentals and investor sentiment," Bank of England working papers 608, Bank of England.
    • Handle: RePEc:boe:boeewp:0608
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    More about this item

    Keywords

    Stock and bond market volatility; two-factor volatility model; macroeconomic fundamentals; structural vector autoregression; Bayesian estimation;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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