We revisit the relation between stock market volatility and macroeconomic activity using a new class of component models that distinguish short-run from long-run movements. We formulate models with the long-term component driven by inflation and industrial production growth that are in terms of pseudo out-of-sample prediction for horizons of one quarter at par or outperform more traditional time series volatility models at longer horizons. Hence, imputing economic fundamentals into volatility models pays off in terms of long-horizon forecasting. We also find that macroeconomic fundamentals play a significant role even at short horizons.
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