Forecasting aggregate stock market volatility with industry volatilities: The role of spillover index

In this paper, we aim to improve the predictability of aggregate stock market volatility with industry volatilities. The empirical results show that individual industry volatilities can provide useful predictive information, while the predictive contribution is limited. We further consider the spillover index between industry volatilities and find it displays strong predictive power for stock market volatility. Based on the portfolio exercise, we find that a mean-variance investor can achieve sizeable economic gains by using volatility forecasts of the spillover index. In addition, we conduct three extended analyses and further demonstrate the superior performance of the spillover index. Also, our results show robustness to a series of alternative settings. Finally, we investigate why the spillover index performs better and answer what information it contains. The results show that the spillover index can reflect and explain investor sentiments that are related to stock market volatility.