Volume 29, Issue 5, 2020
DOI: 10.24205/03276716.2020.1117
Does Uncertainty Affect Investor Behaviors and Returns in Stock Exchanges? A New Generation Analysis for the US Equity Markets
Abstract
This study aims to investigate the relationship between uncertainty level in stock exchanges and stock exchange returns. For this purpose, the effects of the US Equity Market Uncertainty Index (EMUI) on the NYSE, the S&P500, the Dow Jones and the Nasdaq100 stock exchange indexes traded in the US are analyzed using a dataset spanning through 1985:M01-2020:M01. In addition, the US Industrial Production Index and the Non-Farm Employment data along with the FED interest rate are included in the analysis as control variables in order to capture the effect of real economic activities and monetary policy on stock exchange returns. Based on the Carrion-i-Silvestre et al. (2009) multiple structural change unit root test, all series are found to follow I(1). The series are also found to be cointegrated according to the result of the Maki (2012) multiple structural variation cointegration test. Long and short-term analyses are performed using the DOLS method. The long-term analysis suggests that an increase in uncertainty in stock markets negatively affects the returns of all four stock exchanges while the NYSE being the most affected one among others. Moreover, an increase in the Industrial Production Index positively affects all four stock exchange while again the NYSE is found to be the index that is affected the most by such an increase. The Non-Agricultural Employment growth also positively affects all stock exchanges with Nasdaq100 technology index bearing the highest impact. Furthermore, increases in interest rates negatively affects all four stock exchanges operating in the US. The results from the short-term analysis implies that an increase in uncertainty in equity markets negatively affects the stock exchanges investigated. However, this negative effect is less for the NYSE and the S&P500 and greater for the Dow Jones and the Nasdaq100 when compared to the effect obtained from the long-term analysis. Lastly, an increase in the Industrial Production Index affects all four stock exchanges positively in the short-term with the NYSE being the most affected index among the four. Causality relations from uncertainties in equity markets towards the stock exchange returns is analyzed by using a time-varying causality method proposed by Li et al. (2016). According to the results, it is observed that causality from uncertainties in stock exchanges are more apparent on the NYSE, the S&P500 and the Dow Jones while it is relatively less on the Nasdaq100. In general, the causality effects from uncertainties in stock exchanges to stock exchange returns increase during periods in which the Federal Reserve has played a more active role in the US monetary policies.
Keywords
Uncertainty, Equity Market Uncertainty Index (EMUI), Investor Reaction, Behavioral Finance, NYSE, S&P 500, Dow Jones, Nasdaq 100, Structural Break Unit Root Test, Structural Break Cointegration Test, DOLS, Time-varying Causality Test