Financial Market Volatility, Macroeconomic Fundamentals and Investor Sentiment

This research paper examines the relationship between the volatility of stock and bond returns with macroeconomic fundamentals.

The paper is relatively unique in its attempt to combine modelling techniques from macroeconomic and finance research that are usually standalone. It is well-established in the finance literature that volatility can be modelled in terms of slow-moving and cyclical components. We integrate this approach into a commonly-used structual VAR approach to modelling macroeconomic variables.

The paper provides useful evidence for links across macro variables and financial markets. In particular, adverse shocks to aggregate demand and supply increase the persistent component of volatility, while shocks to persistent volatility deteriorate macroeconomic fundamentals.