As already discussed, market participants may take a wait-and-see approach
during episodes of elevated EPU, which may affect asset prices, market
It is therefore reasonable to look at the transmission from all-time
high policy uncertainty to financial markets. Insights can be gained from the co-
movement of EPU and a benchmark index for European financial market
uncertainty. The VSTOXX index, which is the implied volatility of options written
on the Euro STOXX 50 Index (Europe’s leading blue-chip index for the euro
area), reflects market expectations of near-term uncertainty and serves as a
good proxy. The VSTOXX and EPU seem to co-move closely until
2016, with similar direction and pace of evolvement.
Since late 2016, however,
there has been a decoupling, with financial markets uncertainty declining to all-
time lows, but EPU moving to all-time highs. Trending also presents the
correlation of the VSTOXX and European EPU indices. Instead of taking a point
estimate, we utilise moving correlations to show potential changes in co-
movement structure over time.
Our estimates indicate that the correlation of the
two evolved in a range of 50% to 80% until 2016.
In 2017, though, there was a significant disconnection,
with correlation down to 40%.