Abstract
In a dynamic model, this paper characterises the interaction between macroeconomic expectation, risk aversion, and market uncertainty. From survey dispersion forecast, we capture macroeconomic expectation using monetary policy uncertainty, business outlook, and consumer confidence, while risk aversion and market uncertainty measures are derived from realised and implied volatilities. We find that shocks to these dispersion measures significantly affect market uncertainty, risk aversion, and macroeconomic variables. Shocks to monetary policy certainty, business outlook, and consumer confidence significantly lower risk aversion and market uncertainty. Shocks to monetary policy stance have a persistent, but minute effect on risk aversion, uncertainty, and macroeconomic variables.
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Notes
See Wright (2012) on monetary policy and the long-term interest rate.
From various perspectives, Schoemaker (1993) provides a discussion on risk-taking concepts.
Nkwoma (2016) shows that unanticipated monetary policy changes affect jump variation in the price of financial market data.
Drechsler and Yaron (2011) demonstrate that a preference for early resolution of uncertainty and time variation in economic uncertainty are essential to generate a variance premium that is positive and time-varying.
\({\text{VIX}}\) is S & P 500 option-implied volatility index with one-month contract, while \({\text{RV}}_{t + 1}^{22}\) represents next month S & P 500 realised variance. While decomposing \({\text{VIX}}\) into uncertainty and risk aversion components, Bekaert et al. (2013) reveal the good performance of these two elements in forecasting uncertainty. Kanas (2013) examines the relationship between \({\text{VIX}}\) and risk return, and Smith et al. (2010) relate US stock returns to business cycle through the equity risk premium.
Our implied volatility is squared and annualised by dividing it by 12.
Short-run restrictions are used in Sims (1980).
To solve for simultaneity issue in identifying monetary policy and stock market relationship, Bjørnland and Leitemo (2009) impose both short- and long-run restrictions and reveal huge interdependency between real stock prices and setting of US interest rates.
Constant terms are included in all models.
Combination of short- and long-run restrictions is introduced in Galí (1992).
This ensures that the model does not undershoot. However, the results using the original values are the same (The results are not included but can be shown on request).
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Inekwe, J.N. Market uncertainty, risk aversion, and macroeconomic expectations. Empir Econ 59, 1977–1995 (2020). https://doi.org/10.1007/s00181-019-01732-2
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DOI: https://doi.org/10.1007/s00181-019-01732-2