Financial market Volatility, macroeconomic fundamentals and investor Sentiment

Ching wai (Jeremy) Chiu, Richard D.F. Harris*, Evarist Stoja, Michael Chin

*Corresponding author for this work

Research output: Contribution to journalArticle (Academic Journal)peer-review

21 Citations (Scopus)
140 Downloads (Pure)


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. Out-of-sample forecasting shows that the components of volatility can improve forecasts of macroeconomic fundamentals, and vice versa.

Original languageEnglish
Pages (from-to)130-145
Number of pages16
JournalJournal of Banking and Finance
Early online date10 May 2018
Publication statusPublished - 1 Jul 2018

Structured keywords

  • AF Financial Markets


  • Bayesian estimation
  • Macroeconomic fundamentals
  • Stock and bond market volatility
  • Structural vector autoregression
  • Two-factor volatility model


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