Volatility Forecasting and the Business Cycle: Evidence from the European Monetary Union

Abstract

Using a recursive modeling approach and data from the Euro area, the following paper analyzes the counter-cyclicity, stock price volatility is believed to demonstrate with respect to the state of the economy. It further tests whether such interdependence is exploitable for volatility forecasting. The sound contribution of this paper is the extension of the in-sample to an out-of-sample analysis. We deliver robust results that greatly challenge the theory of straight and clear-cut link between stock price variability and the state of the economy on an ex ante and ex post basis. Compared with the forecasting ability of an GJR-GARCH-Model, of the implied and historical volatility, the prediction power of macroeconomic and financial information on stock price volatility is practically deprived by the results presented. These underline the information load already incorporated in market prices and stand in line with the efficient-market hypothesis.