Predicting Volatility and Correlations with Financial Conditions Indexes

Journal of Empirical Finance, Vol. 29, 2014

Tinbergen Institute Discussion Paper 13-113/III

26 Pages Posted: 10 Aug 2013 Last revised: 17 Dec 2016

See all articles by Anne Opschoor

Anne Opschoor

Vrije Universiteit Amsterdam

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Michel van der Wel

Erasmus University Rotterdam

Date Written: August 1, 2014

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, including the FCI in volatility and correlation modeling improves Value-at-Risk estimates, particularly at short horizons.

Keywords: Dynamic correlations, Volatility modeling, Financial Conditions Indexes, Bank holding companies

JEL Classification: G17, G23, E44

Suggested Citation

Opschoor, Anne and van Dijk, Dick J.C. and van der Wel, Michel, Predicting Volatility and Correlations with Financial Conditions Indexes (August 1, 2014). Journal of Empirical Finance, Vol. 29, 2014, Tinbergen Institute Discussion Paper 13-113/III, Available at SSRN: https://ssrn.com/abstract=2307872 or http://dx.doi.org/10.2139/ssrn.2307872

Anne Opschoor (Contact Author)

Vrije Universiteit Amsterdam ( email )

De Boelelaan 1105
Amsterdam, NL 1081 HV
Netherlands

Dick J.C. Van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

Michel Van der Wel

Erasmus University Rotterdam ( email )

Burg. Oudlaan 50
Rotterdam, NL 3062 PA
Netherlands

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