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.     

Analyzing hedging strategies for fixed income portfolios: A Bayesian approach for model selection

During the recent European sovereign debt crisis, returns on EMU government bond portfolios experienced substantial volatility clustering, leptokurtosis and skewed returns as well as correlation spikes. Asset managers invested in European government bonds had to derive new hedging strategies to deal with changing return properties and higher levels of uncertainty. In this environment, conditional time series approaches such as GARCH models might be better suited to achieve a superior hedging performance relative to unconditional hedging approaches such as OLS. The aim of this study is to test innovative hedging strategies for EMU bond portfolios for non-crisis and crisis periods. We analyze single and composite hedges with the German Bund and the Italian BTP futures contracts and evaluate the hedging effectiveness in an out-of-sample setting. The empirical analysis includes OLS, constant conditional correlation (CCC), and dynamic conditional correlation (DCC) multivariate GARCH models. We also introduce a Bayesian composite hedging strategy, attempting to combine the strengths of OLS and GARCH models, thereby endogenizing the dilemma of selecting the best estimation model. Our empirical results demonstrate that the Bayesian composite hedging strategy achieves the highest hedging effectiveness and compares particularly favorable to OLS during the recent sovereign debt crisis. However, capturing these benefits requires low transactions cost and efficiently functioning futures 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.

     

Multivariate FIAPARCH modelling of financial markets with dynamic correlations in times of crisis

This paper applies the vector AR-DCC-FIAPARCH model to eight national stock market indices' daily returns from 1988 to 2010, taking into account the structural breaks of each time series linked to the Asian and the recent Global financial crisis. We find significant cross effects, as well as long range volatility dependence, asymmetric volatility response to positive and negative shocks, and the power of returns that best fits the volatility pattern. One of the main findings of the model analysis is the higher dynamic correlations of the stock markets after a crisis event, which means increased contagion effects between the markets. The fact that during the crisis the conditional correlations remain on a high level indicates a continuous herding behaviour during these periods of increased market volatility. Finally, during the recent Global financial crisis the correlations remain on a much higher level than during the Asian financial crisis.     

Asymmetric Correlation and Volatility Dynamics among Stock, Bond, and Securitized Real Estate Markets

We apply a multivariate asymmetric generalized dynamic conditional correlation GARCH model to daily index returns of S&P500, US corporate bonds, and their real estate counterparts (REITs and CMBS) from 1999 to 2008. We document, for the first time, evidence for asymmetric volatilities and correlations in CMBS and REITs. Due to their high levels of leverage, REIT returns exhibit stronger asymmetric volatilities. Also, both REIT and stock returns show strong evidence of asymmetries in their conditional correlation, suggesting reduced hedging potential of REITs against the stock market downturn during the sample period. There is also evidence that corporate bonds and CMBS may provide diversification benefits for stocks and REITs. Furthermore, we demonstrate that default spread and stock market volatility play a significant role in driving dynamics of these conditional correlations and that there is a significant structural break in the correlations caused by the recent financial crisis.     

Transmission of the financial and sovereign debt crises to the EMU: Stock prices,CDS spreads and exchange rates

This paper tests for the transmission of the 2007–2010 financial and sovereign debt crises to fifteen EMU countries. We use daily data from 2003 to 2010 on country financial and non-financial stock market indexes to analyze the stock market returns for three country groups within EMU: North, South and Small. The following results hold for both the North and South European countries, while the smallest countries seem to be relatively isolated from international events. First, we find strong evidence of crisis transmission to European non-financials from US non-financials, but not for financials. Second, in order to test how the sovereign debt crisis affects stock market developments we split the crisis in pre- and post-Lehman sub periods. Results show that financials become significantly more dependent on changes in the difference between the Greek and German CDS spreads after Lehman’s collapse, compared to the pre-Lehman sub period. However, this increase is much smaller for non-financials. Third, before the crisis euro appreciations coincide with European stock market decreases, whereas this relationship reverses during the crisis. Finally, this reversal seems to be triggered by Lehman’s collapse.     

Industry characteristics and financial risk contagion

This article proposes a new measure of tail risk spillover: the conditional coexceedance (CCX), defined as the number of joint occurrences of extreme negative returns in an industry, conditional on an extreme negative return in the financial sector. The empirical application provides evidence of significant volatility and tail risk spillovers from the financial sector to many real sectors in the U.S. economy from 2001 to 2011. These spillovers increase in crisis periods. The CCX in a given sector is positively related to its amount of debt financing and negatively related to its valuation and investment. Therefore, real economy sectors—which require relatively high debt financing and whose value and investment activity are relatively lower—are prime candidates for stock price volatility and depreciation in the wake of a financial sector crisis. Evidence also suggests that the higher the industry’s degree of competition, the stronger the tail risk spillover from the financial sector.     

Time-varying impacts of demand and supply oil shocks on correlations between crude oil prices and stock markets indices

This paper investigates the time-varying impacts of demand and supply oil shocks on correlations between changes in crude oil prices and stock markets returns. The findings, obtained by means of a DCC-GARCH from June 2006 to June 2016, indicate that demand shocks positively affected the correlations between crude oil prices and stock market returns from late 2007 to mid-2008, during the apex of the financial markets volatility; from early 2009 to mid-2013, during global economy recovery from the financial crisis; and after 2015, when uncertainties about the Chinese growth and the US economy upturning arose. The dynamic conditional correlation, obtained after the removal of demand shocks effects, presented an average value of 0.13 when all economy sectors were considered and of 0.03 when the energy sector returns were excluded from the stock index. These correlations, still positive on average, suggest that exogenous supply oil shocks had little impact on US mainly enterprises cash flows over the last 10 years. Exceptions are the periods from 2006 to financial crisis and from 2014 until April 2016, when significant and unpredicted changes in oil market happened, considerably affecting the value of the main US companies.     

A simple indicator of systemic risk

We examine the relevance and effectiveness of stock return correlations among financial institutions as an indicator of systemic risk. By analyzing the trends and fluctuations of daily stock return correlations and default correlations among the 22 largest bank holding companies and investment banks from 1988 to 2008, we find that daily stock return correlation is a simple, robust, forward-looking, and timely systemic risk indicator. There is an increasing trend in stock return correlation among banks, whereas there is no obvious correlation trend among non-banks. We also disaggregate the stock returns into systematic and idiosyncratic components and find that the correlation increases are largely driven by the increases in correlations between banks’ idiosyncratic risks, which give rise to increasing systemic risk. Correlation spikes tend to predict or coincide with significant economic or market events, especially during the 2007–2008 financial crisis. Furthermore, we show that stock return correlations offer a perspective on the level of systemic risk in the financial sector that is not already captured by default correlations. Stock return correlations are not subject to data limitations or model specification errors that other potential systemic risk measures may face. Therefore, we recommend that regulators and businesses monitor daily stock return correlations among those large and highly leveraged financial institutions to track the level of systemic risk.     

Modelling correlation dynamics of EMU sovereign debt markets during the recent turmoil

The purpose of the present study is to explicitly model the correlation dynamics of Eurozone sovereign debt markets. Our analysis runs from 2000 through 2014. Time varying correlations are derived from a dynamic conditional correlation GARCH model (t-cDCC model). We document substantial variability in correlations that is time and region-dependent. Evidence suggests that the Lehman collapse coupled with the German banks’ bailout programme and the events that followed have undermined sovereign debt integration. Moreover, sensitivity analysis provides useful insights that global and regional risk factors play pivotal role in explaining correlation structure both before and after the onset of the Eurozone sovereign debt crisis. We believe that our results entail important implications for market authorities, international fixed income portfolio diversification and asset allocation.     

The impact of the European sovereign debt crisis on banks stocks. Some evidence of shift contagion in Europe

This paper analyzes the influence of the recent European sovereign debt crisis on banks’ equity returns for 15 countries. Our data span the period December 14th 2007 - March 8th 2013 that encompasses several episodes of economic and financial turmoil since the collapse of the subprime credit market. Our contribution to the literature is twofold. First, we use an explicit multifactor model of equity returns extended with a sovereign risk factor. Second, we adopt a Smooth Transition Regression (STR) framework that allows for an endogenous definition of crisis periods and captures the changes in parameters associated with shift contagion. We find that the negative impact of the European sovereign debt crisis on banks’ equity returns has been mostly confined to European banks, whereas U.S. banks appear to be unharmed by its direct impact and may even have benefited from it. Besides, we find some evidence of shift contagion across Europe.     

A comprehensive approach to measuring the relation between systemic risk exposure and sovereign debt

Using an integrated model to control for simultaneity, as well as new risk measurement techniques such as Adapted Exposure CoVaR and Marginal Expected Shortfall (MES), we show that the aggregate systemic risk exposure of financial institutions is positively related to sovereign debt yields in European countries in an episodic manner, varying positively with the intensity of the financial crisis facing a particular nation. We find evidence of a simultaneous relation between systemic risk exposure and sovereign debt yields. This suggests that models of sovereign debt yields should also include the systemic risk of a country's financial system in order to avoid potentially important mis-specification errors. We find evidence that systemic risk of a country's financial institutions and the risk of sovereign governments are inter-related and shocks to these domestic linkages are stronger and longer lasting than international risk spillovers. Thus, the channel in which domestic sovereign debt yields can be affected by another nation's sovereign debt is mostly an indirect one in that shocks to a foreign country's government finances are transmitted to that country's financial system which, in turn, can spill over to the domestic financial system and, ultimately, have a destabilizing effect on the domestic sovereign debt market.     

Analysis of Dynamic Correlation of Japanese Stock Returns with Network Clustering

In this paper, the dynamic correlation of Japanese stock returns is estimated by using the dynamic conditional correlation (DCC–GARCH) model to study their correlation dynamics empirically. It is difficult to fit the model to the whole stock market jointly at the same time; therefore, a network-based clustering is applied for the dimensionality reduction of the sample data. Two types correlation structures are estimated: homogeneous groups of stocks in a balanced size are created by clustering to observe within-group correlation, while a single portfolio that comprises group portfolio returns is also created to observe between-group correlation. The estimation result reveals dynamic changes in correlation intensity represented by the largest eigenvalue of the estimated correlation matrix. A higher level of correlation intensity and volatility are observed during the crisis periods, namely after both the Lehman collapse and the Great East Japan Earthquake, for the between- and within-group correlations. It is also confirmed that the pattern of correlation change is significantly different between the groups. The proposed method is useful for monitoring dynamic correlation of asset returns efficiently in a large scale of portfolio.     

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.     

Sudden stops and liability dollarization: Evidence from Asia's financial intermediaries

Before the currency crisis of 1997–1998, East Asian financial intermediaries borrowed heavily in international markets. During the crisis, the intermediaries' stock market value declined sharply, and a sizable fraction of the institutions were closed or nationalized. We investigate how the short-term and the foreign-currency nature of the intermediaries' international borrowing contributed to these outcomes. From the impact of long-term international debt on the stock returns of surviving intermediaries, we observe the negative effects of the foreign-currency nature of international debt (liability dollarization). From the impact of short-term international debt on the likelihood of firm failure and on the size of surviving intermediaries' assets and liabilities, we observe the negative effects of the short-term nature of international debt (sudden stops).     

Dynamic correlations and volatility linkages between stocks and sukuk: Evidence from international markets

An understanding of volatility and co-movements in financial markets is important for portfolio allocation and risk management practices. The current financial crisis caused a shrinkage in values of most assets, an increased volatility and a threat to the survival of several institutional investors. Managing risks and returns within the classic portfolio theory, when correlations across securities soar, is increasingly challenging. In this paper, we investigate the volatility behavior and the co-movements between sukuk and international stock indexes. Symmetric multivariate GARCH models with dynamic conditional correlations (DCC) were estimated under Student-t distribution. We provide evidence of high correlations between sukuk and US and EU stock markets, without finding the well-known flight to quality behavior affecting Islamic bonds. We also show that volatility linkages between sukuk and regional market indexes are higher during financial crisis. We argue that investors could obtain diversification benefits including sukuk in a well-diversified equity portfolio, given their lower volatility compared to equity. But higher volatility linkages and dynamic correlations during financial crises show that they are hybrid instruments between bonds and equity. Our findings are relevant for institutional investors and asset managers that include Islamic bonds in a diversified portfolio.     

On cross-currency transmissions between US dollar and euro LIBOR-OIS spreads

Using the causality-in-variance and causality-in-mean tests advocated by Hong (2001), we examine volatility and mean transmissions between the US dollar (USD) and euro (EUR) LIBOR-OIS spreads from January 2005 to June 2011. Interestingly, during the global financial crisis period, despite the apparently bidirectional causality-in-mean observed between the two spreads, we find evidence of significant unidirectional causality-in-variance from the EUR to the USD spread, implying information flows driven by the funding behaviors of European financial institutions. On the other hand, during the recent European sovereign debt crisis, we detect no significant causality-in-mean and causality-in-variance between the spreads.     

Sovereign debt and reserves with liquidity and productivity crises

During the recent financial crisis, emerging economies have kept accumulating both sovereign reserves and debt. To account for this empirical fact, we model the optimal portfolio choice of a sovereign that is subject to liquidity and productivity shocks. We determine the equilibrium level of debt and its cost by solving a contracting game between sovereign and international lenders. Although raising debt increases the sovereign exposure to liquidity and productivity crises, the simultaneous accumulation of reserves can mitigate the negative effects of such crises. This mechanism rationalizes the complementarity between debt and reserves.     

当前国际政府债务问题的影响与警示

为应对席卷全球的国际金融危机,各国政府纷纷采取经济刺激措施,代替民间企业和金融机构承担危机成本,这不可避免带来一定的政府债务问题。随着时间的推移,部分政府债务问题逐步凸显,成为全球经济走出危机阴影的障碍。文章分析认为,当前国际上政府债务问题呈现脆弱性、复杂性、集中性和长期性特征,成为全球经济复苏的绊脚石,甚至会给世界各国经济带来灾难性影响。文章同时总结了国际政府债务问题带给我国的启示。     

Dynamic correlations and hedging effectiveness between gold and stock markets: Evidence for BRICS countries

This paper examines the dynamic relationships between gold and stock markets using data for the BRICS counties. For this purpose, we estimate the Asymmetric DCC model for weekly stock and gold data. Our main objective is to examine the time-varying correlations between the two assets and to check the effectiveness of gold as a hedge for equity markets. The empirical results reveal that the dynamic conditional correlations switch between positive and negative values over the period under study. These correlations are low to negative during the major financial crises suggesting that gold can act as a safe haven against extreme market movements. We also evaluate the implications for portfolio diversification and hedging effectiveness for the gold/stock pairs. Our findings suggest that adding gold to a stock portfolio enhances its risk-adjusted return.