Updated: Aug 30, 2019
Implied volatility from Treasury derivatives predicts macroeconomic and financial activity. Treasury yield implied volatility is a useful forward-looking state variable that characterize risks in the macroeconomy (Presented at AEA Annual Meetings, Philadelphia, 2018).
We show that higher implied volatility from the Treasury derivatives market, a proxy for interest rate uncertainty, predicts declining macroeconomic activity and increased macroeconomic uncertainty. To the best of our knowledge, we are the first paper to show empirically that implied volatilities in the Treasury markets predict both the level and the volatility of several macroeconomic variables.
While many papers study the relation between many financial variables and real activity, there remains little agreement on which variables can consistently predict real activity, especially at horizons longer than one quarter (Stock and Watson (2003)). In addition, with a few exceptions such as Schwert (1989) and Bakshi, Panayotov, and Skoulakis (2011) this literature is largely silent on the links between financial markets and macroeconomic volatility.