Measuring the Spillovers of Uncertainty Shocks

Uncertainty shocks affect expectations and corporate profits and mostly transmit globally. This article provides an uncertainty shocks spillover index from the log-ratio of volatility indices to measure the transmission of uncertainty shocks across European financial markets from 2001 to 2018. The index confirms options markets' ability to price the spillover of political, economic, and financial uncertainty shocks, even those due to terror attacks. The role of the UK and Swiss (non-EMU) options markets explaining the transmission of uncertainty shocks declines after the Brexit, while higher uncertainty results in uncertainty shock contagion depending on the moment of the business and financial cycles. Obtained results improve our understanding of the inter-market connectedness and the flow of uncertainty shocks, aiding central banks to explain the effectiveness of monetary policy (forward guidance), policymakers to design effective policies' implementation, and risk managers to buy risk (volatility) protection at the lowest cost