Are Economic Uncertainty Expectations Rational?

Abstract

This study analyzes whether expectations about uncertainty of the global and U.S. economy emanate from the natural dynamics of the U.S. based rational economic fundamentals, or stem from irrational outlook not attributable to any known risk factors. The findings suggest that both the U.S. and the global economic uncertainty expectations are significantly driven by the U.S. economy and stock market related rational factors namely, economic growth, economic risk premium and excess returns. The three Fama and French factors have significant impact on the U.S. economic uncertainty expectations but insignificant role for global economic uncertainty expectations. Foreign currency movements play a significant role for the global economic uncertainty. The impact of the rational factors is higher for the U.S. economic uncertainty expectations than on the global economic uncertainty expectations. Lastly, there exists a positive feedback effect of the U.S. and global and economic uncertainty expectations. Overall, to a significant extent, the expectations of the U.S. economic uncertainty are well captured by the risk factors suggested in the asset pricing literature.