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Predicting volatility and correlations with Financial Conditions Indexes

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  • Opschoor, Anne
  • van Dijk, Dick
  • van der Wel, Michel

Abstract

We model the impact of financial conditions on asset market volatilities and correlations. We extend the Spline-GARCH model for volatility and DCC model for correlation to allow for inclusion of indexes that measure financial conditions. In our empirical application we consider daily stock returns of US deposit banks during the period 1994–2011, and proxy financial conditions by the Bloomberg Financial Conditions Index (FCI) which comprises the money, bond, and equity markets. We find that worse financial conditions are associated with both higher volatility and higher correlations between stock returns, especially during crises. Moreover, inclusion of the FCI in volatility and correlation modeling improves Value-at-Risk estimates, particularly at short horizons.

Suggested Citation

  • Opschoor, Anne & van Dijk, Dick & van der Wel, Michel, 2014. "Predicting volatility and correlations with Financial Conditions Indexes," Journal of Empirical Finance, Elsevier, vol. 29(C), pages 435-447.
    • Handle: RePEc:eee:empfin:v:29:y:2014:i:c:p:435-447
    DOI: 10.1016/j.jempfin.2014.10.003
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    More about this item

    Keywords

    Dynamic correlations; Volatility modeling; Financial Conditions Indexes; Bank holding companies;
    All these keywords.

    JEL classification:

    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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