The Determinants of the Model-Free Positive and Negative Volatilities

Abstract

In this paper we analyze the role of macroeconomic and financial determinants in explaining stock market volatilities in the U.S. market. Both implied and realized volatility are computed model-free and decomposed into positive and negative components, thereby allowing us to compute directional volatility risk premia. We capture the behaviour of each component of implied volatility and risk premium in relation to their different determinants. The negative implied volatility appears to be linked more towards financial conditions variables such as uncertainty and geopolitical risk indexes, whereas positive implied volatility is driven more by macro variables such as inflation and GDP. There is a clear shift in importance from macro towards financial determinants moving from the pre towards the post financial crisis. A mixed frequency Granger causality approach uncovers causality relationships between volatilities and risk premia and macro variables and vice versa, a finding which is not detected with a conventional low frequency VAR model.