Stock market volatility: Identifying major drivers and the nature of their impact

Financial-market risk, commonly measured in terms of asset-return volatility, plays a fundamental role in investment decisions, risk management and regulation. In this paper, we investigate a new modeling strategy that helps to better understand the forces that drive market risk. We use componentwise gradient boosting techniques to identify financial and macroeconomic factors influencing volatility and to assess the specific nature of their influence. Componentwise boosting is capable of producing parsimonious models from a, possibly, large number of predictors and in contrast to other related techniques allows a straightforward interpretation of the parameter estimates. Considering a wide range of potential risk drivers, we apply boosting to derive monthly volatility predictions for the equity market represented by S&P 500 index. Comparisons with commonly-used GARCH and EGARCH benchmark models show that our approach substantially improves out-of-sample volatility forecasts for short- and longer-run horizons. The results indicate that risk drivers affect future volatility in a nonlinear fashion. (C) 2015 Elsevier B.V. All rights reserved.