Uncertainty and US stock market dynamics

This study investigates the long-term and dynamic relationship between US sector stock returns and risk factors, focusing on uncertainty. Uncertainty risk factors include volatility indices associated with the equity (VIX), fixed-income (TYVIX), oil (OVX), and foreign exchange (EUVIX) markets. The cointegration analysis shows that VIX, TYVIX, OVX, and EUVIX are collectively driving forces of US sector indices in the long run. The causality testing results reveal that uncertainty about long-term interest rates, as proxied by TYVIX, exerts a significant effect on US stock market performance across sectors. Interestingly, in determining the variability of sector stock returns, we find that shocks to the uncertainty of crude oil prices and the exchange rate play a more important role than shocks to their levels. Risk diversification opportunities are identified. •Uncertainty risk factors are relevant determinants of sector stock returns.•Volatility indices are collectively driving forces of sector indices in the long run.•Shocks to the uncertainty of oil price are more relevant than shocks to its level.•Shocks to the uncertainty of the exchange rate are more relevant than level shocks.•Derivatives linked to EUR/USD volatility may be employed for risk diversification.