When volatility turns, recessions follow

Abstract

Do shifts into high stock-market volatility foreshadow recessions rather than merely accompany them? Prior work shows volatility rises in downturns and can help short-horizon forecasts, but the timing of discrete volatility regime changes relative to business-cycle turning points is less understood. Using quarterly data for the United States, United Kingdom, Japan, Germany, Italy, and France (1960–2019; country-specific start dates), we estimate a bivariate Markov-switching model that jointly classifies high/low output growth and high/low return volatility, and tests restrictions on the transition structure. In the United States, United Kingdom, Japan, and France, entry into the high-volatility state typically precedes recession onset by one to two quarters. For Germany and Italy, the output and volatility state processes are approximately independent. These results suggest that volatility-regime switches are a medium-horizon early-warning signal, consistent with uncertainty and risk-premium repricing that tighten funding conditions in more market-based financial systems.