Causality between volatility and the weekly economic index during COVID-19 : the predictive power of efficient markets and rational expectations

We investigate the predictive power of the Efficient Market Hypothesis (EMH) and rational expectations (RE) during periods of economic shocks" specifically COVID-19, captured by the response of the CBOE's volatility index (VIX) to the newly compiled weekly economic index (WEI). We extend upon the literature by examining if CBOE's volatility index (VIX) is correctly influenced by anticipated economic activity, WEÃŽt+1. Employing the recently developed methodology of Hatemi-J (2012, 2021), and the time-varying robust Granger causality test (TVR-GC) of Rossi and Wang (2019) we investigate the symmetric and asymmetric causality" running to VIX from expected values of WEI in the US, in the first 42-50 weeks of the COVID-19 pandemic starting from the 3rd week of January 2020. We find evidence of asymmetric and time-varying causality between the indices after the first few weeks of the pandemic, suggesting that agents respond asymmetrically to information, providing evidence in support of the EMH and RE. The results indicate that investors do not respond rationally to news and make abnormal gains only during the first few weeks of a pandemic announcement.