Who drives the dance? Further insights from a time-frequencywavelet analysis of the interrelationship between stock markets and uncertainty

Using multivariate continuous wavelet tools this paper empirically investigates the strength and the magnitude of the relation between two measures of uncertainty, namely economic policy uncertainty index and implied volatility index, and stock market returns in Europe and United States. The multiple wavelet coherency not only highlights a significant contagion effect between the US and the European stock markets in times of crisis, but also indicates that the intensity of the interdependence between the stock markets and uncertainty indices is more persistent in times of stress and crisis periods. The results also indicate that, both in the U.S. and Europe, when partial coherencies are significant, the partial phase-differences consistently highlight a negative co-movement between the stock markets returns and their corresponding implied volatilities, with the implied volatility indices leading the stock markets for most of the time span and across all frequency bands at which the stocks and the fear indices have co-moved significantly. The wavelet partial gain suggests that the European stock market is relatively more resilient than the U.S. stock market.