On the Relationship between Economic Policy Uncertainty and the Implied Volatility Index

Abstract

This article examines the effects of economic policy uncertainty (EPU) on the implied volatility index. The implied volatility index of various markets has been analyzed in relation to scheduled macroeconomic announcements, such as EPU and equity market policy uncertainty (EMPU) indices. The study highlights that EPU contains important information to explain the diverse market effects of the U.S., which is gauged into the volatility index. Estimates obtained in an autoregressive conditional heteroscedasticity framework indicate the persistence of volatility during spikes in the EPU. More importantly, the lagged values of the policy uncertainty index also contains market-related information to explain the markets’ future volatility. Major political and economic events have also contributed positively in that a presidential election contains information to explain various asset classes. Commodities, such as crude oil, gold, corn, and soybean, have been impacted significantly followed by EPU. Moreover, interest rate market volatility has also been moved adversely due to tight monetary policy. The Markov regime switching regression manifests that the implied volatility index (VIX) behaves abruptly in two different regimes followed by EPU.

Which popular predictor is more useful to forecast international stock markets during the coronavirus pandemic: VIX vs EPU?

“…Even before the coronavirus crisis, we get similar conclusion that VIX index is the most predictive for most of the stock market. Possible reason can be that, as is known to all, VIX is also regarded as the “panic index”, and it tends to rise before news is released ( Shaikh, 2019 ), while the EPU is constructed from daily news, which makes VIX may contains more predictive information than EPU index. Therefore, it is maybe the potent characteristics within these two uncertainty indexes that make VIX and EPU have different forecasting performances.…”

Impact of COVID-19 pandemic disease outbreak on the global equity markets

“…Hence, during the period of ambiguity, investors are unaware of the future consequences of the market and keep on buying put options. Consequently, the VIX level increases (e.g., Shaikh, 2017Shaikh, , 2019. For example, the majority of the equity stock exchange replicates the method of CBOE VIX to calculate investors' sentiment in the near term.…”

Enhancing Portfolio Performance and VIX Futures Trading Timing with Markov-Switching GARCH Models

“…In a first news sentiment study, Shaikh [44] test the influence that the Economic Policy Uncertainty Index (EPUI) of Baker, Bloom and Davis [45] has in the performance of the VIX index. The EPUI is a news sentiment index estimated for several countries (including the U.S.) and this author find, with a two-regime MS model, that the EPUI has an important and direct influence in the VIX value; as a useful conclusion for the present paper for trading decisions.…”