The predictability of stock market volatility in emerging economies: Relative roles of local, regional, and global business cycles

• Author: Rangan Gupta,Xiaojin Sun,Elie Bouri,Riza Demirer
• DOI: http://doi.org/10.1002/for.2672
• Published date: 01 September 2020
• Date: 01 September 2020

Received: 19 July 2019 Revised: 10 October 2019 Accepted: 17 January 2020

DOI: 10.1002/for.2672

RESEARCH ARTICLE

The predictability of stock market volatility in emerging

economies: Relative roles of local, regional, and global

business cycles

Elie Bouri1Riza Demirer2Rangan Gupta3Xiaojin Sun4

1USEK Business School, Holy Spirit

University of Kaslik, Jounieh, Lebanon

2Department of Economics and Finance,

Southern Illinois University Edwardsville,

Edwardsville, Illinois, US

3Department of Economics, University of

Pretoria, South Africa

4Department of Economics and Finance,

University of Texas at El Paso,El Paso,

Texa s, US

Correspondence

Elie Bouri, USEK Business School, Holy

Spirit University of Kaslik, Jounieh,

Lebanon.

Email: eliebouri@usek.edu.lb

Abstract

This paper explores the role of business cycle proxies, measured by the out-

put gap at the global, regional, and local levels, as potential predictors of stock

market volatility in the emerging BRICS nations. We observe that the emerg-

ing BRICS nations display a rather heterogeneous pattern when it comes to

the relative role of idiosyncratic factors as a predictor of stock market volatility.

While domestic output gap is found to capture significant predictive information

for India and China particularly, the business cycles associated with emerging

economies and the world in general are strongly important for the BRIC coun-

tries and weakly for South Africa, especially in the postglobal financial crisis

era. The findings suggest that despite the increase in the financial integration of

world capital markets, emerging economies can still bear significant exposures

to idiosyncratic risk factors, an issue of high importance for the profitability of

global diversification strategies.

KEYWORDS

BRICS, Business Cycles, Forecasting, Stock Market Volatility

JEL CLASSIFICATION

C22; C53; E32; G10

1INTRODUCTION

Return volatility is a key component of asset valuation,

hedging, as well as portfolio optimization models.

Inaccurate forecasts of volatility may lead to mispricing

in financial markets, over/underhedged business risks

and incorrect capital budgeting decisions, with signif-

icant implications on earnings and cash flows. To that

end, monitoring and modeling stock market volatility

are crucial not only for investors and corporate decision

makers, but also for policymakers in their assessment of

financial fundamentals and investor sentiment. In one

of the pioneering studies, building on the stock pricing

models of Shiller, (1981a, 1981b) implying that stock

market volatility is driven by the uncertainty factors that

relate to the volatility of cash flows and the discount factor,

Schwert (1981) suggests that business cycle fluctuations

affect both future cash flow projections and the discount

factor, and hence stock market volatility. This argument

has been recently empirically supported for the USA and

other developed stock markets (Canada, Japan and the

UK) by Choudhry, Papadimitriou, and Shabi (2016) and

Demirer et al. (2019), based on tests of causality. In the

case of emerging markets, however,several recent studies,

including Nier et al. (2014) and Miranda-Agrippino and

Rey (2019), argue the presence of a global financial cycle to

drive asset prices in global markets, partially driven by the

monetary policy decisions by the US Fed (Bruno & Shin,

Journal of Forecasting. 2020;39:957–965. wileyonlinelibrary.com/journal/for © 2020 John Wiley & Sons, Ltd. 957