Global financial uncertainty is a complex combination of country, region, and overall global market volatility

Global financial uncertainty is a critical component of global macro trading aa well as having a real economic effect. Higher volatility will impact correlations across markets and with time series as well as increasing the dispersion of returns and risk premia around the globe. Recent work on a new Global Financial Uncertainty index was completed by researchers at the central Bank of Finland, discussion paper 1.2021. It provides further insight on the dynamic impact of uncertain across markets. 

The researchers looked at realized daily volatility for stocks, bonds, and exchange rates for a large sample of countries to create one single uncertainty index. Note that this uncertainty measure actually is a cross-asset volatility index. The researchers use a dynamic hierarchical factor model to measure the relationships across regions and countries. This factorization can be used as an assessment of uncertainty on subcomponents such as a global, region, or country measure. 

This global financial uncertainty (GFU) index is correlated with periods of market stress; however, it is different or captures different risks than found in the financial cycle or in world industrial production variation. The combination of equity, bond, and exchange rate volatility provides a deeper measure of uncertainty than a single market volatility index. 

There is a clear measurable uncertainty multiplier whereby an increase in the uncertainty index will lead to further or deeper declines in economic activity. The authors also find that there are unique regional behaviors There is higher uncertainty associated with a set of countries that may face a common shock or are relatively open so there is a financial link or spillover from one country to another. 

It is also clear that all global shocks will not impact all countries the same way. Clearly, uncertainty shocks to large economies will have spillover effects to other parts of the world. A US or EU increase in uncertainty will spill-over to most other financial markets. Nonetheless, EM regions like Asia and LATAM may be sensitive to their regional shocks but will not be affected by increases in uncertainty that may happen in the EU. 

What happens to financial market volatility as measured by the GFU index may not be connected to other measures of uncertainty and risk. There is a high correlation between this multi-country and asset index and the VIX index at .86. However, the GFU is less correlated with US financial uncertainty and financial cycle index. A global index will capture regional and country dislocations, and the financial cycle is not the same and an aggregate volatility measure.  Additionally, the policy uncertainty indices that capture news headline measures of uncertainty are correlated with financial volatility measures. Still, uncertainty in the news is not always related to uncertainty in market prices. 

All of this work points to the importance of tracking global volatility and uncertainty if you want to trade across regions and markets. Trade cannot be effectively measured without continual tracking of cross-market uncertainty.