Title: Economic policy uncertainty as an indicator of abrupt movements in the US stock market
Authors: Theologos Pantelidis - University of Macedonia (Greece)
Paraskevi Tzika - University of Macedonia (Greece) [presenting]
Abstract: A two regime switching model is developed as an attempt to relate expected US stock market returns to deviations from fundamentals and to Economic Policy Uncertainty (EPU). The analysis is based on monthly data that cover the period from January 1900 to December 2017 and the EPU index is used as an explanatory variable. The findings suggest that the US stock market spends most of the time in a low-volatility regime, periodically switching to a high-volatility regime during periods of financial instability. In an attempt to examine the forecasting ability of the model, out-of-sample probabilities of a crash and a boom are estimated recursively. The results provide evidence that our model is able to depict periods of abrupt movements in the US stock market. Finally, the estimated model and the associated probabilities of a crash and a boom are used to develop and evaluate trading strategies, in order to analyse the financial usefulness of the model.