Illiquidity and volatility spillover effects in equity markets during and after the global financial crisis: An MEM approach

Even though the volatility spillover effects in global equity markets have been documented extensively, the transmission of illiquidity across national borders has not. In this paper, we propose a multiplicative error model (MEM) for the dynamics of illiquidity. We empirically study the illiquidity and volatility spillover effects in eight developed equity markets during and after the recent financial crisis. We find that equity markets are interdependent, both in terms of volatility and illiquidity. Most markets show an increase in volatility and illiquidity spillover effects during the crisis. Furthermore, we find volatility and illiquidity transmission are highly relevant. Illiquidity is a more important channel than volatility in propagating the shocks in equity markets. Our results show an overall crucial role for illiquidity in US markets in influencing other equity markets' illiquidity and volatility. These findings are of importance for policy makers as well as institutional and private investors.     

Asymmetry in return and volatility spillover between equity and bond markets in Australia

We document asymmetry in return and volatility spillover between equity and bond markets in Australia for daily returns during the period 1992–2006 using a bivariate GARCH modelling approach. Negative bond market returns spillover into lower stock market returns whereas good news originating in the equity market leads to lower bond returns. Bond market volatility spills over into the equity market but the reverse is not true. Transmission of bond volatility into equity volatility depends in a complex way upon the respective signs of the return shocks in each market.     

Time-frequency spillovers among carbon,fossil energy and clean energy markets: The effects of attention to climate change

We explore the time-frequency spillovers among carbon, fossil energy and clean energy markets, and consider the casual effects of climate change attention. The spillover effects among carbon, fossil energy and clean energy markets are time-varying. Carbon market is a net receiver of spillovers from the oil market and clean energy markets in the short term, but it becomes a net transmitter of spillovers to the coal and gas markets in the long term. Our marginal spillover effects analysis suggests that the COVID-19 pandemic has increased cross-market risk contagion in the long term and that carbon market bears larger input risks. Investors' attention to climate change has significant causal effects on the spillovers, and the causal impact of climate change attention on total spillover has significantly increased during the COVID-19 pandemic. Our findings provide important guidelines for investment in environmental protection and demonstrate the importance of formulating differentiated policies for environmental protection in different time horizons.     

Asset Fire Sales and Purchases and the International Transmission of Funding Shocks

We identify a new channel for the transmission of shocks across international markets. Investor flows to funds domiciled in developed markets force significant changes in these funds' emerging market portfolio allocations. These forced trades or “fire sales” affect emerging market equity prices, correlations, and betas, and are related to but distinct from effects arising purely from fund holdings or from overlapping ownership of emerging markets in fund portfolios. A simple model and calibration exercise highlight the importance to these findings of “push” effects from funds' domicile countries and “co‐ownership spillover” between markets with overlapping fund ownership.     

The transmission of market shocks and bilateral linkages: Evidence from emerging economies

The linkage between emerging and developed economies spans beyond the usual trade in goods and services. Underlying trade is the flow of capital for foreign direct investment and for speculation in markets, which renders emerging economies vulnerable to shocks from the developed world. As such, equity return volatility in emerging markets is partly attributable to this dependence. To gauge the importance of bilateral economic and cultural factors in driving economic integration, we adopt a two-step process. First, we use Diebold and Yilmaz's spillover index methodology to extract spillover indices representative of the return volatility spillover effects of the United States, the developed portion of the Euro area, and Japan on financial markets in Asia, the Gulf Cooperation Council countries, Eastern and Central Europe, Africa, and Latin America. Second, we test whether these indices are governed by economic and cultural factors. Our results show that the spillover effects vary across markets and that a strong correlation exists with the volume of trade, security investment, common language, distance, and market capitalization.     

Sources of time varying return comovements during different economic regimes: evidence from the emerging Indian equity market

We study the economic and non-economic sources of stock return comovements of the emerging Indian equity market and the developed equity markets of the US, UK, Germany, France, Canada and Japan. Our findings show that the probability of extreme comovements in the economic contraction regime is relatively higher than in the economic expansion regime. We show that international interest rates, inflation uncertainty and dividend yields are the main drivers of the asymmetric return comovements. Findings reported in the paper imply that the impact of interest rates and inflation on return comovements could be used for anticipating financial contagion and/or spillover effects. This is particularly critical since during extreme market conditions, the tail return comovements can potentially reveal critical information for active portfolio management.     

Quantifying the extreme spillovers on worldwide ESG leaders' equity

With the increasing consensus about the severity of climate change, environmental, social, and governance (ESG) philosophy has been rising and remarkably integrated into green investors' portfolio decisions. This paper applies the novel quantile-based VAR spillover index methods and examines the spillovers among worldwide ESG leaders' equity markets under different market states. Overall, the significant spillovers among global ESG leaders' equity can be captured. The Northern American and E.U. markets are the main risk transmitters to the global ESG investment market. Based on the quantile connectedness analysis, the spillovers among worldwide ESG leaders' equity are more significant for extreme market states than the normal states. Meanwhile, the downward tail risk spillover is larger than the upper. Thus, this paper obtains an asymmetric “U” shape curve to describe the total spillovers across different quantiles. The dynamic estimation also supports the asymmetric characteristics of the cross-market spillover effects and suggests external events could shape the pattern of dynamic connectedness. The potential determinants of total and net extreme spillovers are also investigated to help increase investors' awareness of ESG risk management decisions. Our findings eventually provide a crucial understanding of global ESG investment and indicate some targeted investment implications.     

Bond market integration of emerging economies and bilateral linkages

Although there are numerous studies that have looked at the spillover effects in equity markets, little attention has been paid to explore the integration of bond markets of developed and emerging economies. Our paper is an attempt to fill this void by quantifying the spillovers from developed countries on the bond markets of 25 emerging economies. We apply volatility and return spillover models to quantify the extent of the spillovers from developed markets (i.e. the United States, UK and Japan) into emerging bond markets. We find that the extent of the return spillovers and volatility spillovers has not been symmetric across emerging markets. We explain these differences using bilateral factors such as trade volume, portfolio investment, cultural and geographical factors. The bilateral trade volume turns out to be the leading explanation for the extent of spillovers between our set of countries.     

Stock market development under globalization: Whither the gains from reforms?

Over the past decades, many countries have implemented significant reforms (including financial liberalization, privatization, and regulatory and supervisory improvements) to foster domestic capital market development. Despite these policies, the performance of capital markets in several countries has been disappointing. To understand the effects of reforms, we study the impact of six capital market reforms on domestic stock market development and internationalization. We find that reforms tend to be followed by increases in domestic market capitalization and trading. But reforms are also followed by an increase in the share of activity in international equity markets, with potential negative spillover effects.     

Returns,Volatilities, and Correlations Across Mature,Regional, and Frontier Markets: Evidence from South Asia

We investigate returns, volatilities, and correlations across mature, dominant regional, and frontier equity markets. Standard & Poor's 500 is chosen as a mature equity market; India is chosen as a dominant regional market; and Bangladesh, Pakistan, and Sri Lanka are chosen as frontier markets. Our empirical tests show that the frontier markets remain fundamentally decoupled from the mature markets during normal market periods. During turbulent times, the contagion effects from the mature to the frontier markets become more pronounced. The results suggest that the dominant regional market plays a key role in disseminating shocks across the frontier markets during normal periods; during the turbulent recent financial crisis period, a similar contagion is not observed.     

Taming polysemous signals: The role of marketing intensity on the relationship between financial leverage and firm performance

This study traces the degree of integration and volatility spillover effect between the Pakistani and leading foreign stock markets by analyzing the Meteor shower hypothesis. Daily data are used from nine worldly equity markets (KSE 100, NIKKEI 225, HIS, S&P 500, NASDAQ 100, DOW JONES, GADXI, FTSE 350 and DFMGI) for the period of 2005 to 2014. First, we used the whole data set and after that we split data set into two subsets, First subset of data contains the era of global financial crisis of 2008 from 2005 to 2009 and Second subset is after global financial crisis time period from 2010 to 2014 (The global crisis prevailed till end of 2009). By following the Hamao et al. (1990) technique the univariate GARCH type models are employed to explore the dynamic linkages between Pakistani and leading foreign stock markets. The results from whole data set illustrate that there is mixed co‐movements between leading foreign stock markets and Pakistani stock market. The results from both subsets provide an evidence that there is a unidirectional mean and volatility spillover effect from S&P 500, NASDAQ 100, DJI and DFMGI to KSE 100. Also we found bidirectional spillover effect between DFMGI and KSE 100 from both subsets of data. We concluded that there is only one indirect linkage through which may the information transmitted to KSE 100. This linkage is developed due to the co‐movement among KSE 100, DFMGI and NASDAQ 100 in crisis period. This integration between these markets may provide a sign of indirect linkage. It also exhibits the volatility in Pakistan stock market returns is instigated through direct effects as well as indirect effects. Our study brings important conclusions for financial institutions, portfolio managers, market players and academician to diagnose the nature and level of linkages between the financial markets.     

Speculator activity and the cross-asset predictability of FX returns

This paper tests the gradual information diffusion hypothesis, which suggests that information spreads gradually across asset markets, to explain the role of speculator activity in the cross-asset return predictability of foreign exchange (FX) market strategies. We argue that the activity of speculators increase the rate of information diffusion across asset markets. Hence, we expect the predictive effect from the equity and commodity markets on FX market strategies to be weaker when speculators are active in the FX market. Our results show that, when speculator activity is high, the equity market's ability to predict the FX market dissipates, but not to the same extent as for the commodity market. Our findings suggest that speculators play a vital role in enhancing informational efficiency in the FX market.     

Local and spillover shocks in implied market volatility: evidence for the U.S. and Germany

The occurrence and the transmission of large shocks in international equity markets is of essential interest to the study of market integration and financial crises. To this aim, implied market volatility allows to monitor ex ante risk expectations in different markets. We investigate the behavior of implied market volatility indices for the U.S. and Germany under a straightforward mean reversion model that allows for Poisson jumps. Our empirical findings for daily data in the period 1992 to 2002 provide evidence of significant positive jumps, i.e. situations of market stress with positive unexpected changes in ex ante risk assessments. Jump events are mostly country-specific with some evidence of volatility spillover. Analysis of public information around jump dates indicates two basic categories of events. First, crisis events occurring under spillover shocks. Second, information release events which include three subcategories, namely—worries about as well as actual—unexpected releases concerning U.S. monetary policy, macroeconomic data and corporate profits. Additionally, foreign exchange market movements may cause volatility shocks.     

Net Equity and Debt Flows to Emerging Market and Developing Economies in the Post-Crisis Era

We investigate the determinants of net equity and debt flows into 60 emerging and developing countries during 1986–2012, with a special focus on the period following the onset of the global financial crisis (GFC). Our results controlling for endogeneity show that net equity flows to emerging markets were mostly influenced by global risk factors, while net debt flows were affected by country-specific factors. We further distinguish the factors that were more pronounced in determining net portfolio flows to emerging markets since the GFC. The US real interest rate had significant spillover effects on net equity flows after the GFC. An increase in country’s domestic credit attracted net debt inflows before the GFC, while it was associated with net equity outflows after the GFC. We also find that capital controls moderated net debt flows since the GFC.     

Financial development and innovation: Cross-country evidence

We examine how financial market development affects technological innovation. Using a large data set that includes 32 developed and emerging countries and a fixed effects identification strategy, we identify economic mechanisms through which the development of equity markets and credit markets affects technological innovation. We show that industries that are more dependent on external finance and that are more high-tech intensive exhibit a disproportionally higher innovation level in countries with better developed equity markets. However, the development of credit markets appears to discourage innovation in industries with these characteristics. Our paper provides new insights into the real effects of financial market development on the economy.     

Capital Market Regimes and Bank Structure in Europe

We hypothesize that fundamental features that distinguish European capital markets have predictably influenced emerging national differences in bank capitalization and loan growth. Using bank‐level data from 13 European countries, 1998 to 2004, we find evidence of positive effects of “equity‐friendly” market features on bank capitalization and positive effects of both “equity‐friendly” and “credit‐friendly” market features on loan growth. The findings are strongest in small banks and in banks with cooperative charters. Our results suggest that ongoing and prospective integration of European banking markets is mitigated by relatively static features of the equity and credit markets on which banks rely.     

Contemporaneous Spillover Effects between the U.S. and the U.K. Equity Markets

We use high frequency data and the “identification through heteroskedasticity” approach of Rigobon (2003) to capture the contemporaneous volatility spillover effects between the U.S. and U.K. equity markets. We demonstrate the relevance of taking into account the information present during simultaneous trading hours by comparing the results generated by our structural vector autoregression with those of a traditional reduced-form vector autoregression. Our findings clearly demonstrate that contemporaneous relations matter and that ignoring them leads to inappropriate conclusions regarding the magnitude and direction of volatility spillover.     

Trading externalities and new equity issues in emerging markets

The volatility in emerging market finance over the last decade has highlighted the importance of developing equity exchanges to enhance risk sharing between international investors. Debt markets do not allow for as much risk sharing. Theoretically, stock market development involves trading externalities, as the decision by one firm to list provides a positive spillover for other firms considering an initial offering. This theory thus has a clear policy implication in terms of deliberate government action to promote stock market development. This paper tests empirically for the existence of trading externalities in developing countries, and finds evidence of such externalities for Latin American, but not Asian, stock markets.     

Volatility spillovers and dynamic correlation in European bond markets

This paper examines the dynamic linkages among the European bond markets. We model the price and volatility spillovers from the US bond market and the aggregate Euro area bond market to twelve individual European bond markets using an EGARCH model that allows for a dynamic correlation structure. Our results suggest that significant volatility spillovers exist from both the aggregate Euro area bond market and the US bond market to the individual European markets. Moreover, the introduction of the Euro has strengthened the volatility spillover effects and the cross-correlations for most European bond markets.     

Risk contagion among international stock markets

We develop a stochastic volatility model with jumps in returns and volatility to analyze the risk spillover from the U.S. market and the regional market to a number of European countries’ equity markets. The key advantage of this approach compared to the earlier approaches is that it enables us to identify jumps and investigate spillover of extreme events across borders. We find that a large part of the jumps in the local markets are due to the U.S. market and the regional market. The U.S. contribution to the variances is in general below the contribution from the regional market. In general, we observe an increasing integration during the last two decades, which, to some extent, can be related to the advancement of the European Union. Furthermore, we show that the identification of the jumps can be used as a useful signal for portfolio reallocation.