Taken collectively, the outcomes present a transparent disagreement. Whereas VIX-related uncertainty is primarily a short-term phenomenon, coverage uncertainty evolves over time, reflecting the slow-moving nature of macro and coverage adjustments.
The VIX displays uncertainty in market costs. When it rises, buyers find yourself paying for cover, which corresponds to elevated short-term threat: deeper drawdowns and decrease hit charges. Returns may be higher because the VIX rises, however the path is extra unstable and the advantages fade over time.
In distinction, EPU captures coverage noise. There’s little proof of a constant relationship with draw back threat, with drawdowns being related throughout regimes and typically even bigger after intervals of low coverage uncertainty. That sign is extra pronounced in long-term returns than in threat.
From a sensible perspective, the VIX is a helpful measure of market threat however a weak predictor of returns, whereas the EPU offers some perception into long-term returns however restricted steerage on threat.
Complicated the 2 can result in systematic errors. In different phrases, they are going to be overcautious when markets are steady regardless of excessive coverage uncertainty, and they are going to be undercautious when markets are actively pricing in worry.
