Global financial stress index and long-term volatility forecast for international stock markets

Abstract

In this study, we examine the long-term predictive role of the global financial stress index (GFSI) on equity market volatility and provide a comprehensive analysis using GFSI for the realized volatilities of 21 international stock indices. By focusing on the out-of-sample analysis, we show that GFSI has strong predictive information in forecasting the long-term realized volatilities for most of these equity indices, and it performs better than the Chicago Board Options Exchange volatility index (VIX), the United States economic policy uncertainty (USEPU), global economic policy uncertainty (GEPU), and geopolitical risk (GPR). In terms of the predictive performance during the COVID-19 pandemic, we further show the significantly effective role of GFSI for the long-term realized volatilities of equity markets. In dealing with the high-level global financial stress, our study helps policymakers from many countries to prevent large market fluctuations and decrease economic damage, and facilitate market participants to form better risk-aversion investment strategies.