Predicting volatility and correlations with Financial Conditions Indexes

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  • Anne Opschoor, VU University Amsterdam, the Tinbergen Institute, Ukendt
  • Dick van Dijk, Erasmus University Rotterdam, Tinbergen Institute, ERIM, Holland
  • Michel van der Wel

We model the impact of financial conditions on asset market volatilities and correlations. We extend the Spline-GARCH model for volatility and DCC model for correlation to allow for inclusion of indexes that measure financial conditions. In our empirical application we consider daily stock returns of US deposit banks during the period 1994-2011, and proxy financial conditions by the Bloomberg Financial Conditions Index (FCI) which comprises the money, bond, and equity markets. We find that worse financial conditions are associated with both higher volatility and higher correlations between stock returns, especially during crises. Moreover, inclusion of the FCI in volatility and correlation modeling improves Value-at-Risk estimates, particularly at short horizons.

OriginalsprogEngelsk
TidsskriftJournal of Empirical Finance
Vol/bind29
Sider (fra-til)435-447
Antal sider13
ISSN0927-5398
DOI
StatusUdgivet - 1 dec. 2014

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