Equity Markets Volatility, Regime Dependence and Economic Uncertainty: The Case of Pacific Basin

TL;DR

This paper analyzes how the volatility of the Asia 50 ETF relates to economic and market sentiment indicators across different regimes, revealing regime-dependent dynamics and limited predictive power of sentiment during high volatility.

Contribution

It introduces a regime-switching model to examine the varying impact of economic uncertainty on market volatility, highlighting the importance of regime dependence in financial analysis.

Findings

Relationship between volatility and sentiment varies by regime.

Weak association between short-term volatility and sentiment indicators.

Robustness of regime estimates across quantiles confirmed.

Abstract

This study investigates the relationship between the market volatility of the iShares Asia 50 ETF (AIA) and economic and market sentiment indicators from the United States, China, and globally during periods of economic uncertainty. Specifically, it examines the association between AIA volatility and key indicators such as the US Economic Uncertainty Index (ECU), the US Economic Policy Uncertainty Index (EPU), China's Economic Policy Uncertainty Index (EPUCH), the Global Economic Policy Uncertainty Index (GEPU), and the Chicago Board Options Exchange's Volatility Index (VIX), spanning the years 2007 to 2023. Employing methodologies such as the two-covariate GARCH-MIDAS model, regime-switching Markov Chain (MSR), and quantile regressions (QR), the study explores the regime-dependent dynamics between AIA volatility and economic/market sentiment, taking into account investors' sensitivity to market uncertainties across different regimes. The findings reveal that the relationship between realized volatility and sentiment varies significantly between high- and low-volatility regimes, reflecting differences in investors' responses to market uncertainties under these conditions. Additionally, a weak association is observed between short-term volatility and economic/market sentiment indicators, suggesting that these indicators may have limited predictive power, especially during high-volatility regimes. The QR results further demonstrate the robustness of MSR estimates across most quantiles. Overall, the study provides valuable insights into the complex interplay between market volatility and economic/market sentiment, offering practical implications for investors and policymakers.