Article
Financial market risk and macroeconomic stability variables: dynamic interactions and feedback effects
Journal of Economics and Finance
(2020)
Abstract
This study investigates dynamic interactions and feedback effects between financial
market risk proxied by VIX and key macroeconomic stability variables that
include the rate of unemployment, headline inflation and market-based inflation
expectations reflected by the breakeven inflation. We argue that market risk should
play a stronger role in macroeconomic modeling and forecasting than it has been
recognized thus far in the literature. We employ vector autoregression with
impulse response functions, as well as two-state Markov switching tests to examine
these interactions on the longest available US monthly data. The empirical
tests show that the association between market risk and macroeconomic fundamentals
is predominantly neutral at normal, predictable economic conditions. It
becomes very pronounced at times of financial distress, in the environment of
elevated market risk coupled with uncertain expectations for macroeconomic
variables. Shocks in VIX have a longer impact on macroeconomic stability than
that generally claimed in the prior literature. The Markov switching tests for CPI
and breakeven inflation indicate that households and businesses are concerned
primarily about episodes of increasing inflation, while bond market participants
worry mainly about declining inflation and deflation.
Keywords
- market risk,
- VIX,
- unemployment,
- headline inflation,
- breakeven inflation
Disciplines
Publication Date
Winter January 22, 2020
DOI
10.1007/s12197-020-09505-9
Citation Information
Lucjan T. Orlowski. "Financial market risk and macroeconomic stability variables: dynamic interactions and feedback effects" Journal of Economics and Finance (2020) ISSN: 1055-0925 Available at: http://works.bepress.com/lucjan_orlowski/61/