Financial Market Volatility, Monetary Policy and Economic Fluctuations

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This research program focuses on the formation of volatility expectations in financial markets, their behaviour around monetary policy meetings, and the interdependencies between market volatility and the real economy. The main empirical results indicate that the model-free implied volatility index constitutes an important measure of financial instability and economic uncertainty. The usefulness of CSFI-VXJ volatility index disseminated by the Center for the Study of Finance and Insurance, Osaka University is also reflected by references in articles from The Nikkei newspaper and The Economist magazine. In addition to evidence on nonlinearities in the formation of volatility expectations, it is shown that policy announcements may have stabilizing effects on financial markets by dissipating pre-meeting excessive volatility. Also, shocks to volatility expectations may be transmitted into the leading diffusion index of the Japanese economy, which is indicative of turning points in the business cycle, through a deterioration of consumer confidence, decrease in the investment climate index and flattening of the term structure of interest rates. On aggregate, these results shed some light on the complex relations between economic uncertainty, financial market volatility, and economic information.