Impact Of Economic Policy Uncertainty On Equity Market Volatility

Research Background

The research has dealt with the understanding the impact of Economic Policy Uncertainty on the equity market volatility. The rationale of the research is to suggest that uncertainty take place in fiscal, monetary and regulatory policies that can be recovered in future. It is necessary for analyzing the policy uncertainty role through developing an EPU index (Kang, Lee and Ratti 2014). The research has great significance as it explained indices can have great market-use variations as commercial data for it offers attributes or addressing bank demands, hedge funds along with corporate and policy makers in the UK market. Such adoption pattern reveals that indices include likely information that supports rational decision makers.

The current research aims to investigate the ways in which uncertainty within the economic policy has a great impact on total volatility within the equity markets. Objectives of the recent research are mentioned under:

• To investigate relationship economic policy nature and whether it can be associated with the equity market fluctuations
• To investigate the ways in which economic policy uncertainty impacts equity markets volatility
• To analyze the vital factors of economic policy that impacts equity market fluctuations
• To investigate certain factors that facilitates in realizing correlation among economic policy uncertainty and equity markets volatility

According to Carrière-Swallow and Céspedes (2013) index of strategy, related economic in-decision is relied on the coverage frequency. This intends to capture individuals those are responsible in conducting economic strategy pronouncements. Moreover, it also focuses on analyzing the economic policies those are required being assumed along with consideration the time that will be taken by economic policies can impact the strategic action or else indecisions in consideration to distinct economic implication. Lean and Nguyen (2014) also indicated that index of strategy-related economic indecision is relied on the coverage frequency. This also intends to capture the individuals those are accountable in making economic strategy pronouncements that indicated the economic policies required being assumed and the time in which the economic policies can affect strategy actions or else indecision associating with indecisions in association with distinct economic implications.

The extra criteria include the nearness of at least one-classification pertinent terms: “the Fed”, “national bank”, “premium rate”, “swelling” et cetera for the money related arrangement class, for instance (Bachmann, Elstner and Sims 2013). The reference section reports the full arrangement of terms that characterize eleven strategy classifications and sub-classifications. News bank has been classified for the class lists, since its high content thickness encourages estimation by time period and arrangement class. Caldara et al. (2016) revealed that strategy instability identified with monetary controls and qualification programs likewise climbed pointedly after 2008, yet from at first bring down levels. Concerns identified with sovereign obligation and cash emergencies are up by a request of size amid 2010 to 2013, from a smaller base to have meagre impact on general list of EPU. EPU concerns identified with financial arrangement are imperative all through the 1985-2014 periods, yet maybe shockingly, they are not hoisted as of late by our measure. Several researches such as of Fernández-Villaverde et al. (2015) deciphered this outcome as an impression of low and stable expansion rates as of late, which clearly drive daily paper scope more than question among expert financial analysts about unpredictable money related approaches.

Research Aim and Objectives

As stated by Liu and Zhang (2015) employing the newspaper-based measures of economic policy indicates the economic uncertainty that results in certain concerns related to accuracy and daily bias. This indicates explaining the audit research that focuses on reading the newspaper articles. Kelly, Pástor and Veronesi (2016) gathered that this necessitates auditing through choosing the set of P-term and contrasting it with the human behaviour in specific time-series and indices that are generally generated by computer. These need taking into account the function of political slant in the mentioned index of UK market. It is also gathered that there are certain aspects of indecision that includes volatility within stock market, indecision taking place and strategy ambiguity consultations within all the dimensions of risk elements. Liu and Zhang (2015) revealed that many filings are essentially relied on government strategies and the directives along with occurrence existent within daily stock arcade that centres on distinct government strategy. Kelly, Pástor and Veronesi (2016) explained that the review section investigates the Economic Policy Uncertainty probability to the volatility of stock market. In addition, such sample suggestion indicates that high EPU can indicate significant upsurge in the market instability. This also signifies that integration of EPU tends to serve as supplementary analytical variable from the existing volatility likelihood models that signifies enhances anticipating model’s capability. In contrast, Antonakakis, Chatziantoniou and Filis (2013) major enhancement is deemed vigorous and is associated with the model specifications in an appropriate manner.

Bloom (2014) indicated that in order to measure policy-based economic uncertainty, an index could be built with three aspects. One of the aspects takes into account the coverage of newspaper in relation to policy-based economic uncertainty. Another main element denotes the number and anticipated revenue effects of provision set are related to federal tax code to expire within upcoming years. Another component employs disagreement between economic forecasters regarding policy-based variables being a proxy for the economic policy uncertainty. According to Baker, Bloom and Davis (2016) worries over strategy questionable matter have intensifier in the get of the worldwide budgetary. Taticchi, Tonelli and Cagnazzo (2010) recommend that vulnerability encountered with urban decay was because of deindustrialization, innovation developed, government login. Stainton, Johnson and Borodzicz (2010) reflected those recurrence from claiming articles On 10 heading us daily papers that hold numerous the Emulating triple:. “economic” or “economy”; “uncertain” alternately “uncertainty”; Furthermore person alternately A greater amount of “congress”, “deficit”, “Federal Reserve”, “legislation”, “regulation” or “White House”.

Indices Employed for Strategy Categories

Research carried out by Stainton, Johnson and Borodzicz (2010) explained that at the time of stock market crashes, political uncertainty could be quite high. It is also likely that stock market volatility can be a result of policy uncertainty. Another perception is that economic policy uncertainty is not associated to the market volatility and plays a vital role in the way market sets price for assets. For such reasons, the type of linkages must be investigated that is EPU and the equity markets. The EPU list is a new measure for instability, yet there are few papers identified with the impacts of monetary arrangement instability on securities exchange change. The share trading system unpredictability list (VIX) has been typically considered as a marker for market vulnerability, yet Taticchi, Tonelli and Cagnazzo (2010) expressed that vulnerability over monetary arrangement is here and there more significant than market unpredictability. Lean and Nguyen (2014) brought up that the part of financial strategy instability is specifically identified with how the market costs itself. The connection of financial approach instability file and S&P 500 record has been between 0.62 what’s more, 0.86 amid the period from November 2002 to October 2012 and yet after 2009, monetary approach instability is not reflected in advertise instability measured by the VIX.

Since the connection between the EPU record and market’s suggested profit development has been striking from that point onward, Carrière-Swallow and Céspedes (2013) indicated that market is evaluating monetary arrangement instability over market unpredictability. It is obvious that the pattern of inferred profit development proposed by the model of Lean and Nguyen (2014) it was gathered that nearly takes after the conduct of the EPU list and is adversely corresponded to the level of EPU list. Relapse examination of Carrière-Swallow and Céspedes (2013) elaborated that the determined values in light of the level of one-month fluctuation of S&P500 file think little of the inferred unpredictability, however including financial arrangement instability as an extra illustrative variable expands the exactness of the model. In light of these comes about we have discovered that financial approach vulnerability assumes a critical part in securities exchange elements and the EPU file offers a decent benchmark for e.g. portfolio chance experts. Still, further investigation of the effect of the EPU file on the relationship between stocks and bonds is required. Antonakakis, Chatziantoniou and Filis (2013) offered likewise prove that financial strategy instability drives lead organizations and family units to decrease spending, venture and procuring and express that the impact is bigger for firms with more prominent presentation to government arrangement.

Analyzing Policy In-decision Measures

The researcher has deployed the methods of quantitative research and this is also justified as such technique can focus on several objective measurements and the numerical, mathematical and numerical or else the statistical analysis of gathered information’s employing distinct computational techniques (Anderson and Shattuck 2012). In the current research, the researcher focuses on fooling appropriate code of conduct in accomplishing tasks in several data collected process. Moreover, quantitative data has been presented through graphs and tables that have further simplified the collected data’s interpretation technique.

In order to carry out the current research, quantitative research was considered to be carried out through employing descriptive research design in order to determine the impact of the economic policy variations based on the fluctuations within the equity market (Barratt, Choi and Li 2011). Certain variables have been considered in the recent study as the independent variables and at the same time equity markets volatility as dependent variables within the research. In addition, there are several control variables in the regression evaluation, which can investigate the total robustness of the economic policy uncertainty influence on the unstable movement within the equity markets. Specifically, provisional discrepancy within the market portfolio might be taken into account as the major control variable that can facilitate in macroeconomic shock accounting, which in turn might affect the total stock volatility. Exploratory research design was employed in the current research as this technique focuses on preparing a list of recommendations for decreasing the issues at the completion of the research (Coyne et al. 2010).

Relevant data has been collected from secondary data for carrying out the recent research. The sources of the secondary data might be internal data that encompass databases of distinct data information sources from company along with distinct media that encompass articles from the important magazines, non-profit agencies in UK, newspapers and reports obtained from several university research units (Denzin 2012). The researcher in the current research intends to collect relevant data from the UK news index and FTSE 100 for the duration of 10 years on a monthly basis. Moreover, simple random sampling has been employed in this research gathering relevant data through selected sample, as it offers equal chance to the respondents of being selected in the reassert. For this reason, quantitative data has been gathered through employing random sampling a huge sample.

The researcher also focuses to measure the economic strategy uncertainty through employing an audit research that specifically relies on the reading on distinct newspaper articles (Flood 2010). Such research methodology is relied on intensity of newspaper coverage that has the aim to gather the individuals those make the policy pronouncements and the pecuniary strategy actions might be assumed and the impacts of the economic strategy. This will be employed for the development economic policy uncertainty index both monthly and the everyday numerical of UK. For this reason, it can be stated that the researcher has considered carrying out audit study relied on the recent results of the EPU index along with a comparative research of historical EPU indices (Gioia, Corley and Hamilton 2013). Implementation of secondary data for carrying out the research is deemed justified for this has facilitated the researcher to attain access to certain information easily at a decreased cost. In addition, the secondary research can also facilitate in the clarification process of the reassert objectives and supports in addressing all the study objectives. Moreover, the researcher has also focused on interpreting the gathered information through employing quantitative techniques those re necessarily used in mathematical and statistical processes for instance descriptive and inferential statistics, correlation and regression for evaluating the collected data (Henson, Hull and Williams 2010).

Link between EPU and the Performance of Equity Markets

In this chapter, the researcher has provided a clear understanding of the effects of uncertainty related to economic policy on equity market volatility. Therefore, the researcher has considered the use of secondary data to be deemed fit for this research purpose. The researcher used descriptive as well as inferential statistics to summarise the data collected. In addition, the researcher has used both correlation and regression analyses in order to determine the relationship between economic policy uncertainty and the UK equity market. This has helped the researcher to identify various factors of economic policy affecting fluctuations in UK equity market. This has helped the researcher in identifying various factors affecting the fluctuations in the equity market.

The following research questions have been framed in order to arrive at the desired outcome of the research:

• How the economic policy uncertainty is related to the stock movements?
• How policy uncertainty exerts influence on equity market volatility?
• Is there any additional factor like relative dividend growth and inflation to assist in the projection of economic policy uncertainty impact on the market volatility?

Research aims and objectives:

The current research intends to scrutinise the way through which the economic policy uncertainty has direct influence on the volatility in UK equity market. The objectives of the research have been undernoted:

• To examine the nature of relationship between economic policy uncertainty and stock market volatility
• To identify the various influential dynamics of economic policy resulting in fluctuation of equity markets
• To ascertain the various supplementary factors to understand the correlation between economic policy uncertainty and equity market volatility

In order to conduct secondary analysis, the researcher has accumulated secondary data in the form of UK News Index and FTSE 100 stock prices for the past ten years. Therefore, the researcher has applied descriptive statistics, correlation coefficient and regression analyses to evaluate the above collected data. The results of the descriptive statistics and correlation coefficient between the two variables have been depicted as follows:

 Table 4.1: Descriptive statistics and correlation coefficient of the UK News Index and FTSE 100 historical prices on ten-year data

(Source: As created by author)

Figure 4.1: Trend of FTSE 100 prices and UK News Index from 2007 to February 2017

(Source: As created by author)

It has been observed that uncertainty is directly associated with market volatility and it minimises the growth rate of the equity rate. Thus, higher market volatility denotes increase in the stock prices of the equity market and vice-versa. However, from the above figure, it has been found that there is fluctuation in the UK equity market despite the increase or decrease in UK news index. This is because it has been found that with the rise in UK news index, the price of the UK equity market has increased as well. From the mean value, it has been found that the economic policy uncertainty index has remained at an average of 232.201715. On the other hand, the mean value of UK equity market has been obtained as 5974.747541. This depicts that the economic uncertainty has controlled impact on volatility of the UK equity market. For instance, it could be observed that after the economic downturn of 2007, the UK news index has reached maximum to 251.49 in 2008 and the price of FTSE 100 has declined to 4,337.34 in the same period from 4,902.45 (past month).

The standard deviation obtained for both the variables has been below the mean value, which depicts that the level of economic certainty is low in UK and there is lower amount of risk involved in the equity market of UK. According to the quartile values, it could be evaluated that that 25% of the values of UK news index are below the range of 142.2442538, while 75% of the values of the UK news index are below the range of 269.0601178. In case of the UK stock index, 25% of the stock values have been below 5557.755, while 75% of the stock values have been below 6578.84. The possible reasons identified behind such index trend include supply side shock, demand side shock and financial instability. The rise in the global oil prices has lead to increase in the production cost of the companies listed in the UK stock index. Due to such scenario, it has resulted in cost-push inflation. Due to this, the economic growth of the nation has been hindered due to increased inflation.

In addition, another factor identified behind the falling index trend of the UK equity market is the demand side shock in the form of global economic downturn of 2007. For instance, due to the recessionary effects on European Union, the UK market has experienced a decline in exports and overall economic growth. As a result, it has lowered down the price of the UK equity market. Along with this, many global banks have been closed and as a result, the investors have lost their trust in the financial system. Thus, the above-mentioned factors of economic policy have resulted in fluctuations of the UK equity market, which satisfies the first research question.

From the correlation coefficient value of 0.21, it has been evaluated that the UK News Index and the UK stock market have positive correlation between each other; however, the relation is not highly significant. It has been observed that uncertainty affects the stock market on both micro and macro levels. From the micro-level perspective, it has been found that uncertainty is a serious concern for those UK companies listed in FTSE 100 producing daily consumer products. During the global recession, the consumption has declined in the UK market, as the individuals abstain themselves from buying new cars, computers and other non-necessary items. As a result, certain organisations listed in FTSE 100 have laid off their staffs for fighting with the impact of lower sales. However, despite such scenario, some investors have continued to invest in the stocks of different companies listed in FTSE 100, although a good number of investors have withdrawn their investments during that time. Due to this, the stock trend of FTSE 100 has declined; however, the decline is not intense in contrast to the other markets. This is denoted by positive correlation coefficient.

The following hypotheses have been developed based on the research question:

H₀: Higher-level economic policy uncertainty does not lead to higher volatility in equity markets

H₁: Higher-level economic policy uncertainty leads to higher volatility in equity markets

Table 4.2: Regression analysis showing the impact of economic policy uncertainty on the UK equity market

(Source: As created by author)

In order to conduct the regression analysis, the researcher has accumulated past data of 10 years month wise for each of the two variables. In this case, the economic policy uncertainty has been chosen as the independent variable, while the UK equity market has been selected as the dependent variable. The UK News Index data has been acquired for the independent variable, while the historical prices of the UK stock market have been obtained for the dependent variable. The four major elements that have been taken into consideration in order to ascertain the relationship between the two chosen variables include multiple-R, R-square, F-value and P-value.

From the value of multiple-R, which is obtained as 0.21, it could be stated that the economic policy uncertainty and UK stock index has 21% internal relationship with each other. In addition, the R-square value has been obtained as 0.0449, which depicts that the relationship between the two variables is 4.49% statistically fit. Hence, from these above two values, it could be said that the volatility rate of the UK stock index has been 4.49%, which is exerted on the part of UK News Index. This satisfies the second research question of identifying the pressure policy uncertainty exerts impact on stock market volatility.

The F-value is obtained as 5.64843 in order to test the relationship between the two variables. In case, if the value of F is above 0.05, the better is the relationship between the two variables. In this case, the F-value is above 0.05, which signifies that economic policy uncertainty has positive impact on the UK stock index. In addition, the P-value has been considered as well for determining the association between the two variables. If the P-value is below 0.05, it denotes that there is strong association between two variables. In this case, the P-value is obtained as 0.01905, which is below the average P-value of 0.05. Due to the global inflation, the organisations listed in FTSE 100 index have reduced their relative dividends due to lower amount of sales. The lowering amount of sales has reduced their net profits, due to which the dividend payout and retained earnings of the organisation have declined. Therefore, it could be stated that economic price volatility has strong impact on the equity market of UK. This satisfies the third research question, which states that inflation and dividend growth rate assists in the prediction process of economic uncertainty. Thus, the alternative hypothesis holds good in this case.

The researcher has considered the use of secondary data to be deemed fit for this research purpose. The researcher used descriptive as well as inferential statistics to summarise the data collected. In addition, the researcher has used both correlation and regression analyses in order to determine the relationship between economic policy uncertainty and the UK equity market. . During the global recession, the consumption has declined in the UK market, as the individuals abstain themselves from buying new cars, computers and other non-necessary items. As a result, certain organisations listed in FTSE 100 have laid off their staffs for fighting with the impact of lower sales. However, despite such scenario, some investors have continued to invest in the stocks of different companies listed in FTSE 100, although a good number of investors have withdrawn their investments during that time. Due to the global inflation, the organisations listed in FTSE 100 index have reduced their relative dividends due to lower amount of sales. The lowering amount of sales has reduced their net profits, due to which the dividend payout and retained earnings of the organisation have declined. Therefore, it could be stated that economic price volatility has strong impact on the equity market of UK.

Conclusion:

The aim of this research is to scrutinise the way through which the economic policy uncertainty exerts influence on the volatility in UK equity market. after the economic downturn of 2007, the UK news index has reached maximum to 251.49 in 2008 and the price of FTSE 100 has declined to 4,337.34 in the same period from 4,902.45 (past month). Due to this, the stock trend of FTSE 100 has declined; however, the decline is not intense in contrast to the other markets. This is denoted by positive correlation coefficient. it could be said that the volatility rate of the UK stock index has been 4.49%, which is exerted on the part of UK News Index. This satisfies the second research question of identifying the pressure policy uncertainty exerts impact on stock market volatility.

This research has focused on evaluating the impact of economic policy uncertainty on equity market volatility of UK. The researcher has failed to consider the other indexes to improve the quality of the research. In addition, the lack of time constraint and budget are other factors that have hindered the researcher in improving the quality. This is because additional timeframes for the research could have helped in improving research quality further.

The researcher could consider larger data set by including the other global stock indexes. In addition, the researcher could conduct the study for 20 years, instead of 10 years to improve the scope of the research. Finally, the researcher could have used additional statistical tools like Garch model in order to improve the quality of the research.

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