On financial contagion and implied market volatility

This paper investigates volatility contagion across U.S. and European stock markets during the Global Financial Crisis (GFC) and the Eurozone Sovereign Debt Crisis (ESDC). Using a sample of international implied volatility indices on daily changes, I explore asymmetric conditional correlation dynamics across stable and crisis periods and across the different phases of both crises. Empirical evidence indicates the existence of contagion in cross-market volatilities. A different pattern of infection is observed across the phases, since the early phase of the GFC and the late period of escalation of the Euro crisis are the most contagious periods. This implies that the initial signal of the two crises has been differently recognized by implied volatility markets. The results provide important implications for the effectiveness of international portfolio diversification and volatility hedging during periods of negative shocks.     

Spreading the fear: The central role of CBOE VIX in global stock market uncertainty

Construction of efficient portfolios is reliant on understanding the correlation between assets. If correlations change markedly during times of economic turmoil then investors are exposed to greater risk at the most inopportune time. We examine the linkages between global stock markets using measures of market uncertainty (implied volatility). Using a sample of daily changes in G7 and BRIC implied volatility measures, over a 20-year sample period, we demonstrate that uncertainty in U.S. markets plays a pivotal role in global stock market uncertainty. “Fear is spread” across markets, as heightened uncertainty in U.S. markets is transmitted across global markets. Conversely, changes in global market uncertainty do not explain changes in U.S. market uncertainty. While there is a clear increase in connectedness during crisis periods, we observe a disparity in the way that inter-dependencies change during the two major economic crises in our sample period; the GFC (2007–2009) and COVID-pandemic (2020). The additional importance of US news largely drives our results during the GFC, while the effect is spread among several countries (particularly within European markets) during COVID.     

Linkages between Indian and US financial markets: impact of global financial crisis and Eurozone debt crisis

This paper examines inter-linkages between Indian and US equity, foreign exchange and money markets using the vector autoregressive-multivariate GARCH-BEKK framework. We investigate the impact of global financial crisis (GFC) and Eurozone debt crisis (EZDC) on the conditional volatility and conditional correlation estimates derived from the multivariate GARCH model for Indian and US financial markets. Our results indicate that there is significant bidirectional causality-in-mean between the Indian stock market returns and the Rs./USD market returns, and significant unidirectional causality-in-mean from the US stock market returns to the Indian stock market returns. As regards volatility spillovers, we find that volatility in the Indian stock market rises in response to domestic as well as US financial market shocks but Indian financial market shocks do not impact the US markets. Further, impact of the recent crisis episodes on the covariance matrix is found to be significant. We find that volatility in the Indian and US financial markets significantly amplified during GFC. The conditional correlations across asset markets were significantly accentuated in the wake of the two crisis episodes. The impact of GFC on cross-market conditional correlations is higher for majority of the asset market pairs in comparison to the EZDC.     

Baltic stock markets and the financial crisis of 2008–2009

This study presents new evidence on stock market integration by investigating the linkages between developed European stock markets and emerging stock markets. We focus on three countries in the Baltic region, namely Estonia, Latvia and Lithuania with particular attention to the recent financial crisis of 2008–2009. The study is motivated by traditional stock market studies of integration, which show that developed stock markets are highly integrated, while emerging markets may be segmented. How integrated these emerging stock markets are in a crisis period with respect to the EUROSTOXX50 stock index is an empirical question investigated in this study. While the results of this study demonstrate that the Baltic stock markets were apparently segmented before the crisis, they were highly integrated during the crisis. The results of the variance decomposition analysis show that a large proportion of the forecast variance of the Baltic stock markets can be explained by the EUROSTOXX50 during the crisis. The results from the quantile regressions demonstrate that during the crisis the returns of the lowest quantile were most sensitive to the EUROSTOXX50 stock index. All these results imply less diversification benefits during crises when investors would need them the most.     

Baltic stock markets and the financial crisis of 2008–2009

This study presents new evidence on stock market integration by investigating the linkages between developed European stock markets and emerging stock markets. We focus on three countries in the Baltic region, namely Estonia, Latvia and Lithuania with particular attention to the recent financial crisis of 2008–2009. The study is motivated by traditional stock market studies of integration, which show that developed stock markets are highly integrated, while emerging markets may be segmented. How integrated these emerging stock markets are in a crisis period with respect to the EUROSTOXX50 stock index is an empirical question investigated in this study. While the results of this study demonstrate that the Baltic stock markets were apparently segmented before the crisis, they were highly integrated during the crisis. The results of the variance decomposition analysis show that a large proportion of the forecast variance of the Baltic stock markets can be explained by the EUROSTOXX50 during the crisis. The results from the quantile regressions demonstrate that during the crisis the returns of the lowest quantile were most sensitive to the EUROSTOXX50 stock index. All these results imply less diversification benefits during crises when investors would need them the most.     

Are Islamic stock indexes exposed to systemic risk? Multivariate GARCH estimation of CoVaR

The main objective of this paper is to assess the exposure of Islamic stock indexes to systemic tail events. We use Conditional Value-at-Risk (CoVaR) and Delta CoVaR measures as developed by Adrian and Brunnermeier (2011) and a sample of Islamic and conventional stock indexes, from various developed and emerging markets, during the period September 2005 to March 2015. The empirical results reveal that the systemic risk has a moderate adverse effect on Islamic indexes, with a lower level in Gulf Cooperation Council countries (GCC hereafter). The findings also show the Asian stock indexes can be considered as effective hedge assets, after the global financial crisis (GFC hereafter). Furthermore, the empirical reveal that portfolio including Islamic stock indexes performs better than a benchmark portfolio in turmoil periods. These findings have several implications in financial decisions including the strategy of stability and asset allocation.     

Measuring financial contagion: A Copula approach

This paper models dependence with switching-parameter copulas to study financial contagion. Using daily returns from five East Asian stock indices during the Asian crisis, and from four Latin American stock indices during the Mexican crisis, it finds evidence of changing dependence during periods of turmoil. Increased tail dependence and asymmetry characterize the Asian countries, while symmetry and tail independence describe the Latin American case. Structural breaks in tail dependence are a dimension of the contagion phenomenon. Therefore, the rejection of the correlation breakdown hypothesis should not be considered, without further investigation, as evidence of a stable dependence structure.     

Exchange rate volatility across financial crises

This paper studies the impact of global financial turmoil on the exchange rate policies in emerging countries. Spillovers from advanced financial markets to currencies in emerging countries are likely to be exacerbated during crisis periods. To test this hypothesis, we assess the exchange rate policies by currencies’ volatility and investigate their relationship to a global financial stress indicator, measured by the volatility on global markets. We introduce the possibility of nonlinearities by running smooth transition regressions over a sample of 21 emerging countries from January 1994 to September 2009. The results confirm that exchange rate volatility does increase more than proportionally with the global financial stress, for most countries in the sample. We also evidence regional contagion effects spreading from one emerging currency to other currencies in the neighboring area.     

Unveiling investor-induced channels of financial contagion in the 2008 financial crisis using copulas

Understanding how financial crises spread is important for policy-makers and regulators in order to take adequate measures to prevent or contain the spread of these crises. This paper will test whether there was contagion of the subprime financial crisis to the European stock markets of the NYSE Euronext group (Belgium, France, the Netherlands and Portugal) and, if evidence of contagion is found, it will determine the investor-induced channels through which the crisis propagated. We will use copula models for this purpose. After assessing whether there is evidence of financial contagion in the stock markets, we will examine whether the ‘wealth constraints’ transmission mechanism prevails over the ‘portfolio rebalancing’ channel. An additional test looks at the interaction between stock and bond markets during the crisis and allows us to determine if the transmission occurred due to the ‘cross market rebalancing’ channel or the ‘flying to quality’ phenomenon. The tests suggest that (i) financial contagion is present in all analyzed stock markets, (ii) a ‘portfolio rebalancing’ channel is the most important crisis transmission mechanism, (iii) and the ‘flight-to-quality’ phenomenon is also present in all analyzed stock markets.     

The determinants of stock–bond return correlations

I study the options-implied market risks that affect US stock–bond correlations from 2007 to 2021. I discover that US stock and bond market uncertainty, stock market tail risk, and global credit-default risk are dominant contributors to changing stock–bond correlations during the global financial crisis (GFC) period. However, these market risks collectively contribute much less to time-varying correlations in the post-GFC period. Furthermore, stock–bond correlations rise in times of rising US and global bond market risks. Rising stock market uncertainty raises stock–bond correlations in the GFC period but lowers them in the post-GFC period. My results disentangle the risks of stock and bond markets and show that equity tail risk, bond market risk, and stock market uncertainty are dominant factors in changing stock–bond diversification benefits in periods of market turmoil.     

The 2008 financial crisis: Stock market contagion and its determinants

In this paper, we investigate worldwide contagion and its determinants during the 2008 financial crisis. Utilizing an international sample of returns from 2003 to 2009, we consider both uni- and bi-directional contagion. After controlling for crisis-related volatility, we find strong evidence that cross-market linkages increase among many financial markets. In contrast to previous crises, contagion following the 2008 global financial crisis is not confined to emerging markets. The United States and other mature financial markets in the sample transmit and receive contagion. Country markets are less influenced by regions than they are by other country markets. We also construct variables that represent relative changes in economic variables before and during the crisis. We find that both economic fundamentals such as trade structure, interest rates, inflation rates, industrial production, and regional effects, and investors’ risk aversion contribute to international contagion.     

Comparing COVID-19 with the GFC: A shockwave analysis of currency markets

I analyze the shockwave effect of the COVID-19 pandemic on currency markets, with a comparison to the global financial crisis (GFC), employing Kapetanios m-break unit root test, investigations of standalone risk measures—downside variance, upside risk, volatility skewness, Gaussian Value at Risk (VaR), historical VaR, modified VaR—and Diebold–Yilmaz volatility spillover analysis. Standalone risk analysis shows that the turmoil in the initial months of COVID-19 was not as severe as that in the GFC. However, examination of co-movements and volatility spillovers illustrates a different scenario. According to the results of the static connectedness measure of Diebold–Yilmaz, the shockwave of the COVID-19 pandemic in the total volatility spillover is about eight times greater than that of the GFC. Among standalone risk measures, the results closest to this finding are obtained from volatility skewness analysis. Additionally, of six foreign exchange rates, the Brazilian real and Turkish lira are the currencies experiencing the greatest increase in received volatility during the GFC and the COVID-19 pandemic, respectively. These findings suggest the severe effect of crises on emerging financial markets.     

The US financial crisis,market volatility,credit risk and stock returns in the Americas

We employ the multivariate DCC-GARCH model to identify contagion from the USA to the largest developed and emerging markets in the Americas during the US financial crisis. We analyze the dynamic conditional correlations between stock market returns, changes in the general economy’s credit risk represented by the TED spread, and changes in the US market volatility represented by the CBOE Volatility Index^® (VIX). Our sample includes daily closing prices from January 1, 2002 to December 31, 2015, for the USA and stock markets in Argentina, Brazil, Canada, Chile, Colombia, Mexico, and Peru. We first identify that increases in VIX have a negative intertemporal and contemporaneous relationship with most of the stock returns, and these relationships increase significantly during the US financial crisis. We then find evidence of significant increases in contemporaneous conditional correlations between changes in the TED spread and stock returns. Increases in conditional correlations during the financial crisis are associated with financial contagion from the USA to the Americas. Our findings have policy implications and are of interest to practitioners since they illustrate that during periods of financial distress, US stock volatility and weakening credit market conditions could promote financial contagion to the Americas.

     

The shifting dependence dynamics between the G7 stock markets

The growing interdependence between financial markets has attracted special attention from academic researchers and finance practitioners for the purpose of optimal portfolio design and contagion analysis. This article develops a tractable regime-switching version of the copula functions to model the intermarkets linkages during turmoil and normal periods, while taking into account structural changes. More precisely, Markov regime-switching C-vine and D-vine decompositions of the Student’s t copula are proposed and applied to returns on diversified portfolios of stocks, represented by the G7 stock market indices. The empirical results show evidence of regime shifts in the dependence structure with high contagion risk during crisis periods. Moreover, both the C- and D-vines highly outperform the multivariate Student’s t copula, which suggests that the shock transmission path is as important as the dependence itself, and is better detected with a vine copula decomposition.     

‘Slow-burn’ spillover and ‘fast and furious’ contagion: a study of international stock markets

‘Fast and furious’ contagion across capital markets is an important phenomenon in an increasingly integrated financial world. Different from ‘slow-burn’ spillover or interdependence among these markets, ‘fast and furious’ contagion can occur instantly. To investigate this kind of contagion from the US, Japan and Hong Kong to other Asian economies, we design a research strategy to capture fundamental interdependence, or ‘slow-burn’ spillover, among these stock markets as well as short-term departures from this interdependence. Based on these departures, we propose a new contagion measure which reveals how one market responds over time to a shock in another market. We also propose international portfolio analysis for contagion via variance decomposition from the portfolio manager’s perspective. Using this research strategy, we find that the US stock market was cointegrated with the Asian stock markets during four specific periods from 3 July 1997 to 30 April 2014. Beyond this fundamental interdependence, the shocks from both Japan and Hong Kong have significant ‘fast and furious’ contagion effects on other Asian stock markets during the US subprime crisis, but the shocks from the US have no such effects.     

Financial contagion effects of major crises in African stock markets

This study examines financial contagion effects in African stock markets during major crises over the period 2005 to 2020. We investigate contagion effects in individual stock markets and from a regional perspective using dynamic conditional correlations during the global financial crisis, European debt crisis, Brexit, and COVID-19. The empirical evidence confirms contagion effects in some individual markets. However, significant evidence of contagion is found only during the global financial crisis from the regional perspective. Our findings suggest that the regional impacts of crises differ due to the nature of those crises. We also find financial contagion increases in the country-level risk, market capitalization and export to GDP and decreases in corruption.     

On the volatility spillover between lslamic and conventional stock markets: A quantile regression analysis

This paper aims at analyzing the degree and structure of interdependencies in terms of volatility (transmission, contagion) between Islamic and conventional stock markets on calm periods and at times of financial fragility and crisis. We focused on the recent financial instability periods and used the Quantile Regression-based GARCH model. Main results lead to very interesting conclusions. First, it has been found that Islamic stock markets are not totally immune to the global financial crisis. Second, a very strong interdependence is sensed from the conventional to the Islamic stock markets, especially, from the conventional developed markets to the Islamic Emerging and Arab markets and to the Islamic developed markets. Finally, it has been proved that the interdependencies from conventional to Islamic markets are propagated between Islamic markets. Our findings suggest that the Islamic finance industry does not seem able to provide cushion against economic and financial shocks that affect conventional markets.     

Financial market interdependencies: A quantile regression analysis of volatility spillover

This paper investigates the degree and structure of interdependence between emerging (Asian and Latin American) and developed (USA and Japan) stock markets through the study of volatility spillovers for the period spanning from January 1, 1993 to October 13, 2010. Using both standard GARCH model and quantile regression approach, we find the evidence of significant interdependence between financial markets which may give evidence of volatility transmission. The volatility transmission is closely associated with geographical proximity as well as with crisis periods which confirm the presence of contagion. The analysis of upper and lower quantiles allows observing that the interdependence increases during bullish markets while decreases during bearish markets. Accordingly, the structure of interdependence is asymmetric for both Asian and Latin American emerging markets. These findings open up new insights for government policy makers as well as for managerial purposes.     

Global financial crisis and emerging stock market contagion: A volatility impulse response function approach

By employing the volatility impulse response (VIRF) approach, this paper presents a general framework for addressing the extent of contagion effects between the BRICSs’ and U.S. stock markets and how the BRICSs’ stock markets have been influenced in the context of the 2007–2009 global financial crisis. Our empirical results show during the period of 2007–2009 global financial crisis, there are significant contagion effects from the U.S. to the BRICSs’ stock markets. Yet, the degree of stock market reactions to such shocks differs from one market to another, depending on the level of integration with the international economy. Besides, the strengthened degree of stock market integration among the U.S. and BRICS has adverse effect such that if the 2007–2009 global financial crisis occurs today it may result in heavier impact on stock market volatility nowadays compared to the crisis-era.     

Volatility spillovers and hedging effectiveness between the oil market and Eurozone sectors: A tale of two crises

This paper aims to analyze the mean and volatility spillovers between oil prices and the Eurozone supersector returns. It uses daily data of the Brent prices and 19 Eurozone supersector indices for the period from August 2004 to August 2015. This area experienced two important instabilities in that period, the global financial crisis (GFC) and the Euro debt crisis (EDC). Because financial turbulences are suspected to induce changes in the volatility dynamics, the full sample is divided into three sub-samples. Empirically, this study employs a bivariate VAR-BEKK-GARCH model that allows for transmission in volatility. The obtained volatilities and covariances are used to compute the optimal weights and hedge ratios for oil–stock portfolio holdings. The findings show that both mean and volatility spillovers between the oil market and the different Eurozone sectors are time-varying and heterogeneous. In the GFC sub-period, there is evidence of contagion effects because there is an intensification of volatility spillovers. The EDC does not seem to have induced any particular change in the spillover effects. The optimal weights, hedge ratios, and correlation analysis results allow an accurate understanding of the time series relationship between the two markets and are useful for financial market participants and policymakers.