The interrelatedness of global equity markets, money markets, and foreign exchange markets

This article investigates different aspects of global financial markets, specifically relationships among equity markets, money markets, and foreign exchange markets across countries. To represent the three major financial markets of the world, Japan is the proxy for Asia, Germany is the proxy for Europe, and the United States is the proxy for North America. Strong evidence exists that international money markets and international equity markets are becoming increasingly integrated over time. This article incorporates foreign exchange values as partial determinants of equity returns and money market returns and investigates the interactions among these three asset markets from a global perspective.     

Asian equity markets: growth,opportunities, and challenges

Asian equity markets have grown significantly in size since the early 1990s, driven by strong international investor inflows, growing regional financial integration, capital account liberalization, and structural improvements to markets. The development of equity markets provides a more diversified set of channels for financial intermediation to support growth, thus bolstering medium-term financial stability. At the same time, as highlighted by the May–June 2006 market corrections, the increasing role of stock markets potentially changes the nature of macroeconomic and financial stability risks, as well as the policy requirements for dealing with these risks.     

‘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.     

On emerging stock market contagion: The Baltic region

This study provides new evidence on emerging stock market contagion during the Global Financial crisis (GFC) and the Euro zone Sovereign Debt Crisis (ESDC). Focusing on the three emerging Baltic markets and developed European markets, proxied by the EUROSTOXX50 stock index, we explore asymmetric dynamic conditional correlation dynamics across stable and crisis periods. Empirical evidence indicates a diverse contagion pattern for the Baltic region across the two crises. Latvia and Lithuania were contagious during the GFC, while they were insulated from the adverse effects of the ESDC. On the other hand, Estonia decoupled from the negative consequences during the global turmoil period, but recoupled during the ESDC. The results could be attributed to financial and macroeconomic characteristics of the Baltic countries before and after the turmoil periods and the introduction time of the Euro as a national currency.     

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.     

Investigating risk contagion initiated by endogenous liquidity shocks: evidence from the US and eurozone interbank markets

This paper investigates liquidity spillovers between the US and European interbank markets during turbulent and tranquil periods. We show that an endogenous model with time-varying transition probabilities is effective in describing the propagation of liquidity shocks within the interbank market, while predicting liquidity crashes characterised by changed dynamics. We show that liquidity shocks, originating from movements of the spread between the Asset Backed Commercial Paper and T-bill, drive regime changes in the euro fixed-float OIS swap rate. Our results support the idea of endogenous contagion from the US money market to the eurozone money market during the global financial crisis.     

Volatility Spillovers and Contagion During the Asian Crisis: Evidence from Six Southeast Asian Stock Markets

Using a multivariate generalized autoregressive conditional heteroskedasticity (GARCH-M) model, we investigate volatility spillovers in six Southeast Asian stock markets around the time of the 1997 Asian crisis. We focus on interactions with the U.S. market as a world financial market, and with the Japanese market as a regional financial market. We also use bivariate GARCH-M models to examine the behavior of individual markets and their interactions with other markets in the region. All models lend support to the idea of the "Asian contagion," which started in Thailand and rapidly spread to other markets.     

Unraveling the Financial Contagion in European Stock Markets During Financial Crises: Multi-Timescale Analysis

The article investigates the evidence of financial contagion and market integration in selected European equity markets during nine major crises across regions. The focus is to identify whether (i) contagion evidence is pure or fundamental and (ii) dynamic evolution of integration is in the short run or long run. Wavelet decomposition in both its discrete and continuous forms is used. The findings reveal the following: (i) prior to the subprime crisis, contagion effects generated short-term shocks. The most recent US subprime crisis, however, reveals the evidence of fundamental based contagion. (ii) We find increasing short-run and long-run stock market integration, driven by several stages of the establishment of Economic and Monetary Union (EMU), questioning the ultimate benefits of formal entry into EMU membership.     

Stock market contagion in Central and Eastern Europe: unexpected volatility and extreme co-exceedance

We examine whether there is contagion from the US stock market to six Central and Eastern European stock markets. We use a novel measure of contagion that examines whether volatility shocks in the US stock market coupled with negative returns are followed by higher co-exceedance between US and emerging stock markets. Using our approach and controlling for a set of market-related variables, we show that during the period from 1998 to 2014, financial contagion occurred, that is, unexpected negative events in the US market are followed by higher co-exceedance between US and Central and Eastern European stock markets. Even though contagion is stronger during the financial crisis, it also occurs in tranquil times.     

Unobservable shocks as carriers of contagion

We propose an identified structural GARCH model to disentangle the dynamics of financial market crises. We distinguish between the hypersensitivity of a domestic market in crisis to news from foreign non-crisis markets, and the contagion imported to a tranquil domestic market from foreign crises. The model also enables us to connect unobserved structural shocks with their source markets using variance decompositions and to compare the size and dynamics of impulses during crises periods with tranquil period impulses. To illustrate, we apply the method to data from the 1997–1998 Asian financial crisis which consists of a complicated set of interacting crises. We find significant hypersensitivity and contagion between these markets but also show that links may strengthen or weaken. Impulse response functions for an equally-weighted equity portfolio show the increasing dominance of Korean and Hong Kong shocks during the crises and covariance responses demonstrate multiple layers of contagion effects.     

Fatal attraction: Using distance to measure contagion in good times as well as bad

This paper proposes a new measure of contagion that is good at anticipating future vulnerabilities. Building on previous work, it uses correlations of equity markets across countries to measure contagion, but in a departure from previous practice measures contagion using the relationship of these correlations with distance. Also in contrast to previous work, our test is good at identifying periods of “positive contagion,” in which capital flows to emerging markets in a herd-like manner largely unrelated to fundamentals. Identifying such periods of “fatal attraction” is important as they provide the essential ingredients for subsequent crises and rapid outflows of capital.     

Equity Market Comovement and Contagion: A Sectoral Perspective

This paper takes an asset pricing perspective to investigate the equity market comovement and contagion at the sector level during the period 1990-2004 across the regions of Europe, Asia, and Latin America. It examines whether unexpected shocks from a particular market, or group of markets, are propagated to the sectors in other countries. The results confirm the sector heterogeneity of contagion. This implies that there are sectors that can still provide a channel for achieving the benefits of international diversification during crises despite the prevailing contagion at the market level. In addition, the results lend support to the importance of financial links in the propagation of contagion.     

Liquidity and Return Relationships in an Emerging Market

In this paper, we investigate the relationship between liquidity and stock returns in the Vietnam stock market during the global financial crisis. Vietnam is one of a new group of frontier emerging markets referred to as CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa). We use a rich and detailed data set of firm characteristics to identify a positive relationship between liquidity and stock returns. This contradicts the negative correlation typically found in stock returns in developed markets. Our results support the proposition that when a market is not fully integrated with the global economy, a lack of liquidity will be a less important risk factor. Our findings contribute to those studies that highlight the diversification benefits from including frontier markets, which have a lower degree of integration with the global economy, in international portfolios.     

A multilateral approach to examining the comovements among major world equity markets

This study investigates the comovement in stock indices among major developed markets, where Morgan Stanley Capital International (MSCI) indices are employed for the purposes of the study. We employ a model that accommodates multilateral international impacts on equity index movements. The empirical results reveal the existence of significant international transmission effects among these major world markets, both in terms of returns and volatility, and mostly in a positive direction. The U.S. market, as expected, is the leading market in the sense that it has the most pervasive and significant impact on all markets across continents. However, the U.S. market exhibits a different relationship with European markets from that with Asia-Pacific markets. The evidence also suggests that strong regional transmission effects exist. A further investigation using the extended model reveals that the linkages between U.S. and European markets are driven by positive global common forces and by negative international competitive effects. On the other hand, the U.S. and Asian markets are linked through positive global common forces and positive international contagion effects. The United States, Canada, and the U.K. are the three markets that still demonstrate contagion influence over countries outside its own region. The Asia-Pacific markets are more susceptible to contagion effects. Finally, it is interesting to find that Japanese market performance became more contagious toward other markets during the Asian financial crisis period.     

Jump risk premia across major international equity markets

We decompose the non-diversifiable market risk into continuous and discontinuous components and jump systematic risks into positive vs. negative and small vs. large components. We examine their association with equity risk premia across major equity markets. We show that developed markets jumps are more closely linked to the aggregate market index than emerging and frontier ones. The reward for bearing both the continuous and downside jump risks is positive during the pre-crisis period whereas the reward for bearing the upside and large jump risks is negative during the crisis and post-crisis periods. We also provide evidence of significant continuous and discontinuous leverage effects during the pre-crisis period, suggesting that both continuous and discontinuous price and volatility risks share compensations for common underlying risk factors.     

Dynamic information spillovers in intraregionally-focused spot and forward currency markets

This paper proposes an intraregionally-focused tri-currency modeling framework to investigate dynamic information spillovers across spot and forward exchange rate markets in frontier and emerging country currencies, for both price levels and volatilities. Empirical estimates of structural parameters were obtained using an MGARCH–MSKST model that incorporated the term structure of non-deliverable forward (NDF) and deliverable forward (DF) markets, the dominance of regional currencies, and the influence of differing forward contract maturities (1-, 3-, 6- and 12-months). The currencies for nine countries were grouped into three regions: Northeast Asia (China, Korea and Taiwan); South/Southeast Asia (India, Indonesia and Philippines); and Latin America (Brazil, Chile and Columbia). The currency for each selected country was evaluated within the regionally determined tri-currency system. We found that NDF markets play a dominant role over DF markets with regard to price discovery during periods of tranquility. During periods of crisis, both NDF and DF markets exhibit a more balanced impact on currency market price discovery mechanisms. In addition, distinct differences were observed across regions: currencies in Northeast Asia were shown to be affected by the Chinese renminbi during periods of crisis and the Indian rupee could be regarded as the dominant currency in South/Southeast Asia. No robust results were obtained with regard to the dominance of currencies in Latin America. Finally, our results also suggest important distinctions between the effect of various instrument maturities on NDF and DF market returns – with DF returns being more responsive to longer maturities (6-months and 12-months). During tranquil periods NDF returns are more responsive to shorter maturities, but during crisis periods this effect is diminished.     

The going public decision and the structure of equity markets

The industries in which listed firms are concentrated in less developed equity markets are not random, nor entirely explained by the underlying composition of production. Listed firms and market capitalization are disproportionately concentrated in industries with low beta (measured with their beta with the market portfolio in the U.S.). We document a strong positive relationship between the industry-weighted country beta and the degree of market development across countries. Recent IPO activity confirms the result since new listings have higher betas than the average firm already in the market.     

The macroeconomic content of international equity market factors

Although existing research has examined the association between macroeconomic data and particular equity markets, little is known regarding the economic content of the latent factors common to international equity markets. This paper considers the macroeconomic information incorporated in unobserved common equity market factors, as well as the possibility that the macroeconomic sensitivities of the factors differ across alternative levels of volatility. Several models are estimated for 15 developed equity markets to examine the economic composition of the common factors, thereby providing an alternative perspective on the economic fundamentals underlying equity markets. A formal Bayesian selection process suggests that a common structure incorporating global and European factors is preferred to the baseline case of a single global factor or the extended scenario of dual global factors. The common factors are associated with a small set of macroeconomic variables.     

Mutual funds flows and the geography of contagion

This paper studies the dynamics and geography of investments made by international mutual funds located in advanced markets. I identify precise global and regional dynamics in equity and bond flows. Very few countries receive (or lose) funding in isolation. I also find strong evidence of global contagion: when financial conditions in developed markets change, emerging markets' funding is heavily affected. I illustrate this finding by deriving contagion maps showing where contagion spreads and with what intensity. In general, the results suggest that push effects from advanced market investors affect massively developing countries and expose them to sudden stops and surges.     

Interconnected multilayer networks: Quantifying connectedness among global stock and foreign exchange markets

This paper proposes a novel interconnected multilayer network framework based on variance decomposition and block aggregation technique, which can be further served as a tool of linking and measuring cross-market and within-market contagion. We apply it to quantifying connectedness among global stock and foreign exchange (forex) markets, and demonstrate that measuring volatility spillovers of both stock and forex markets simultaneously could support a more comprehensive view for financial risk contagion. We find that (i) stock markets transmit the larger spillovers to forex markets, (ii) the French stock market is the largest risk transmitter in multilayer networks, while some Asian stock markets and most forex markets are net risk receivers, and (iii) interconnected multilayer networks could signal the financial instability during the global financial crisis and the COVID-19 crisis. Our work provides a new perspective and method for studying the cross-market risk contagion.