Predicting firm-level volatility in the United States: the role of monetary policy uncertainty

Authors

  • Matthew W Clance
  • Riza Demirer
  • Rangan Gupta
  • Clement Kweku Kyei

DOI:

https://doi.org/10.17811/ebl.9.3.2020.167-177

Abstract

Theoretically, there is exists a strong link between monetary policy rate uncertainty and equity return volatility, since asset pricing models assume the risk-free rate to be a key factor for equity prices. Most studies, however, focus on aggregate volatility proxies, ignoring the evidence that idiosyncratic risk could also be an important consideration, particularly for under-diversified investors and arbitrageurs. Given this, we examine firm-level annual data for the United States over 1997 to 2016, and show that monetary policy uncertainty does indeed contain significant predictive information over realized and implied volatilities at both the firm- and industry-level. The predictive power of monetary policy uncertainty is found to be robust across the low and high quantiles of volatility with higher policy uncertainty predicting higher firm-level volatility in subsequent periods. While the strongest possible volatility effect is observed in the case of Retail Trade, we observe opposite resuThis paper provides novel evidence for the This paper provides novel evidence for the predictive power of monetary policy uncertainty (MPU) over stock return volatility at the firm level based on a dataset constructed from 9,458 U.S. firms. Our findings show that monetary policy uncertainty contains significant predictive information over realized and implied volatilities at both the firm- and industry-level, with higher policy uncertainty predicting higher volatility in subsequent periods. While the strongest possible volatility effect is observed in the case of Retail Trade, we observe opposite results for Mining with high policy uncertainty predicting lower volatility in this sector. We argue that the dual nature of the underlying commodity for Mining companies, both as a consumption and investment asset, drives the negative effect of policy uncertainty on volatility in this sector. Nevertheless, the findings highlight the predictive information captured by monetary policy actions on the idiosyncratic component of equity market volatility.predictive power of monetary policy uncertainty (MPU) over stock return volatility at the firm level based on a dataset constructed from 9,458 U.S. firms. Our findings show that monetary policy uncertainty contains significant predictive information over realized and implied volatilities at both the firm- and industry-level, with higher policy uncertainty predicting higher volatility in subsequent periods. While the strongest possible volatility effect is observed in the case of Retail Trade, we observe opposite results for Mining with high policy uncertainty predicting lower volatility in this sector. We argue that the dual nature of the underlying commodity for Mining companies, both as a consumption and investment asset, drives the negative effect of policy uncertainty on volatility in this sector. Nevertheless, the findings highlight the predictive information captured by monetary policy actions on the idiosyncratic component of equity market volatility.lts for Mining with high policy uncertainty predicting lower volatility in this sector. We argue that the dual nature of the underlying commodity for Mining companies, both as a consumption and investment asset, drives the negative effect of policy uncertainty on volatility in this sector. Nevertheless, the findings highlight the predictive information captured by monetary policy actions on the idiosyncratic component of equity market volatility.

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Published

2020-12-13

How to Cite

Clance, M. W., Demirer, R., Gupta, R., & Kyei, C. K. (2020). Predicting firm-level volatility in the United States: the role of monetary policy uncertainty. Economics and Business Letters, 9(3), 167–177. https://doi.org/10.17811/ebl.9.3.2020.167-177