Dynamic interaction between economic policy uncertainty and financial stress: A multi-scale correlation framework

Highlight
- Multi-scale interaction between economic policy uncertainty (EPU) and financial stress (FS) is investigated.
- Correlation is significant and fluctuates drastically in short-term fluctuation with unidirectional spillover effect from FS to EPU.
- Bidirectional spillover effects exists between FS to EPU in the medium pattern with periodic correlation of two-regime characteristic.

Quantifying the dynamic interaction between economic policy uncertainty and financial stress is in its infancy. To identify the inherent relationship between them, this paper proposes a multi-scale correlation framework. Empirical results show that interaction occurs significantly and distinctly on different scales. Correlation is significant and fluctuates drastically in short-term fluctuation with unidirectional spillover effect from financial stress to economic policy uncertainty. Bidirectional spillover effects exist in the medium pattern with periodic correlation of two-regime characteristic. It helps for decision making to establish a proper timing reference to design a more reasonable arbitrage portfolio and improve risk-hedging strategies.