Financial Markets and Portfolio Management

, Volume 31, Issue 3, pp 261–288 | Cite as

Predictive models for disaggregate stock market volatility

  • Terence Tai-Leung ChongEmail author
  • Shiyu Lin


This paper incorporates macroeconomic determinants into the forecasting model of industry-level stock return volatility in order to detect whether different macroeconomic factors can forecast the volatility of various industries. To explain different fluctuation characteristics among industries, we identified a set of macroeconomic determinants to examine their effects. The Clark and West (J Econom 138(1):291–311, 2007) test is employed to verify whether the new forecasting models, which vary among industries based on the in-sample results, make better predictions than the two benchmark models. Our results show that default return and default yield have a significant impact on stock return volatility.


Industry-level stock return volatility Out-of-sample forecast Granger causality 

JEL Classification

C12 G12 



We thank the editor and anonymous referees for their constructive comments, which greatly improved the quality of the paper. We owe much to Liugang Sheng and Julan Du, and seminar participants at The Chinese University of Hong Kong, for their helpful comments. We are also very much indebted to Min Chen, Margaret Loo, Yingshi Chen, Junjie Guo, and Mandy Cheung, for their assistance with the research. Any remaining errors are ours.


  1. Adrian, T., Rosenberg, J.: Stock returns and volatility: pricing the short-run and long-run components of market risk. J. Financ. 63(6), 2997–3030 (2008)Google Scholar
  2. Anderson, T.G., Bollerslev, T., Diebold, F.X.: Roughing it up: including jump components in the measurement, modelling, and forecasting of return volatility. Rev. Econ. Stat. 89(4), 701–720 (2007)Google Scholar
  3. Beltratti, A., Morana, C.: Breaks and persistency: macroeconomic causes of stock market volatility. J. Econom. 131(1–2), 151–177 (2006)Google Scholar
  4. Boudoukh, J., Richardson, M., Whitelaw, R.F.: Industry returns and the Fisher effect. J. Financ. 49(5), 1595–1615 (1994)Google Scholar
  5. Brandt, M.W., Kang, Q.: On the relationship between the conditional mean and volatility of stock returns: a latent VAR approach. J. Financ. Econ. 72(2), 217–257 (2004)Google Scholar
  6. Brennan, M.J., Xia, Y.: Stock price volatility and equity premium. J. Monet. Econ. 47(2), 249–283 (2001)Google Scholar
  7. Campbell, J.Y., Cochrane, J.H.: By force of habit: a consumption-based explanation of aggregate stock market behavior. J. Polit. Econ. 107(2), 205–251 (1999)Google Scholar
  8. Campbell, J.Y., Lettau, M., Malkiel, B.G., Xu, Y.: Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk. J. Financ. 56(1), 1–43 (2001)Google Scholar
  9. Chen, N.F., Roll, R., Ross, S.A.: Economic forces and the stock market. J. Bus. 59(3), 383–403 (1986)Google Scholar
  10. Clark, T.E., West, K.D.: Approximately normal tests for equal predictive accuracy in nested models. J. Econom. 138(1), 291–311 (2007)Google Scholar
  11. Corradi, V., Distaso, W., Mele, A.: Macroeconomic determinants of stock volatility and volatility premiums. J. Monet. Econ. 60(2), 203–220 (2013)Google Scholar
  12. Czaja, M.G., Scholz, H.: Sensitivity of stock returns to changes in the term structure of interest rates—evidence from the German market. Oper. Res. Proc. 2006, 305–310 (2007)Google Scholar
  13. Dinenis, E., Staikouras, S.K.: Interest rate changes and common stock returns of financial institutions: evidence from the UK. Eur. J. Financ. 4(2), 113–127 (1998)Google Scholar
  14. Engle, R.F., Rangel, J.G.: The spline-GARCH model for low-frequency volatility and its global macroeconomic causes. Rev. Financ. Stud. 21(3), 1187–1222 (2008)Google Scholar
  15. Errunza, V., Hogan, K.: Macroeconomic determinants of European stock market volatility. Eur. Financ. Manag. 4(3), 361–377 (1998)Google Scholar
  16. Faff, R.W., Brailsford, T.J.: Oil price risk and the Australian stock market. J. Energy Financ. Dev. 4(1), 69–87 (1999)Google Scholar
  17. Fama, E.F., French, K.R.: Business conditions and expected returns on stocks and bonds. J. Financ. Econ. 25(1), 23–49 (1989)Google Scholar
  18. Fama, E.F., French, K.R.: Industry costs of equity. J. Financ. Econ. 43(2), 153–193 (1997)Google Scholar
  19. Ferson, W.E., Harvey, C.R.: The variation of economic risk premiums. J. Polit. Econ. 99(2), 385–415 (1991)Google Scholar
  20. Flannery, M.J., Protopapadakis, A.A.: Macroeconomic factors do influence aggregate stock returns. Rev. Financ. Stud. 15(3), 751–782 (2002)Google Scholar
  21. Fornari, F., Mele, A.: Financial volatility and economic activity. J. Financ. Manag. Mark. Inst. 2, 155–198 (2013)Google Scholar
  22. Hamilton, J.D., Lin, G.: Stock market volatility and the business cycle. J. Appl. Econom. 11(5), 573–593 (1996)Google Scholar
  23. Hamilton, J.D., Susmel, R.: Autoregressive conditional heteroskedasticity and changes in regime. J. Econom. 64(1–2), 307–333 (1994)Google Scholar
  24. Hess, M.K.: Sector specific impacts of macroeconomic fundamentals on the Swiss stock market. Financ. Mark. Portf. Manag. 17(2), 234–245 (2003)Google Scholar
  25. Humpe, A., Macmillan, P.: Can macroeconomic variables explain long-term stock market movements? A comparison of the US and Japan. Appl. Financ. Econ. 19(2), 111–119 (2009)Google Scholar
  26. Kearney, C., Daly, K.: The causes of stock market volatility in Australia. Appl. Financ. Econ. 8(6), 597–605 (1998)Google Scholar
  27. Mele, A.: Asymmetric stock market volatility and the cyclical behavior of expected returns. J. Financ. Econ. 86(2), 446–478 (2007)Google Scholar
  28. Mele, A.: Understanding stock market volatility: a business cycle perspective. Working Paper, London School of Economics (2008)Google Scholar
  29. Merton, R.C.: On estimating the expected return on the market: an exploratory investigation. J. Financ. Econ. 8(4), 323–361 (1980)Google Scholar
  30. Oertmann, P., Rendu, C., Zimmermann, H.: Interest rate risk of European financial corporations. Eur. Financ. Manag. 6(4), 459–478 (2000)Google Scholar
  31. Officer, R.R.: The variability of the market factor of the New York Stock Exchange. J. Bus. 46(3), 434–453 (1973)Google Scholar
  32. Paye, B.S.: ‘Déjà vol’: predictive regressions for aggregate stock market volatility using macroeconomic variables. J. Financ. Econ. 106(3), 527–546 (2012)Google Scholar
  33. Sadorsky, P.: Risk factors in stock returns of Canadian oil and gas companies. Energy Econ. 23(1), 17–28 (2001)Google Scholar
  34. Sadorsky, P.: The macroeconomic determinants of technology stock price volatility. Rev. Financ. Econ. 12(2), 191–205 (2003)Google Scholar
  35. Schwert, G.W.: Why does stock market volatility change over time? J. Financ. 44(5), 1115–1153 (1989)Google Scholar
  36. Sinha, C.: Changing business conditions and regime switching in stock returns. Working Paper, Owen Graduate School of Management, Vanderbilt University (1996)Google Scholar
  37. Sohn, B.: Cross-section of equity returns: stock market volatility and priced factors. Working Paper, Georgetown University (2009)Google Scholar
  38. Sweeney, R.J., Warga, A.D.: The pricing of interest-rate risk: evidence from the stock market. J. Financ. 41(2), 393–410 (1986)Google Scholar
  39. Tangjitprom, N.: The review of macroeconomic factors and stock returns. Int. Bus. Res. 5(8), 107–115 (2012)Google Scholar
  40. Veronesi, P.: Stock market overreaction to bad news in good times: a rational expectations equilibrium model. Rev. Financ. Stud. 12(5), 975–1007 (1999)Google Scholar
  41. Welch, I., Goyal, A.: A comprehensive look at the empirical performance of equity premium prediction. Rev. Financ. Stud. 21(4), 1455–1508 (2008)Google Scholar
  42. Whitelaw, R.F.: Time variations and covariations in the expectation and volatility of stock market returns. J. Financ. 49(2), 515–541 (1994)Google Scholar

Copyright information

© Swiss Society for Financial Market Research 2017

Authors and Affiliations

  1. 1.Department of Economics and Lau Chor Tak Institute of Global Economics and FinanceThe Chinese University of Hong KongShatinHong Kong
  2. 2.Department of EconomicsThe Chinese University of Hong KongShatinHong Kong

Personalised recommendations