Volatility and shock interactions and risk management implications: Evidence from the U.S. and frontier markets |
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| Institution: | 1. Stetson School of Business and Economics (SSBE), Mercer University, 1501 Mercer University Drive, Macon, GA 31207, United States;2. Surveillance Analyst, Cambridge Investment Research Inc., 1776 Pleasant Plain Road, Fairfield, IA 52556, United States;3. Florida Atlantic University, 777 Glades Road, Boca Raton, FL 33431, United States;1. Finance Discipline Group, UTS Business School, University of Technology Sydney, Australia;2. Department of Econometrics and Business Statistics, Monash University, Australia;3. Accounting and Finance, UWA Business School, The University of Western Australia, Australia;4. Discipline of Finance, The University of Sydney Business School, The University of Sydney, 2006 NSW, Australia;1. Department of Management and Engineering, Linköping University, Linköping, Sweden;2. ESC Rennes School of Business, Rennes, Brittany, France;3. Montpellier Business School, Montpellier, France;4. Department of Economics, Pusan National University, Busan, Republic of Korea;1. Centre for Financial Risk Macquarie University, Sydney, Australia;2. Southwestern University of Finance and Economics, China;3. Queensland Productivity Commission, Brisbane, Australia;1. School of Finance, Southwestern University of Finance and Economics, Wenjiang District, Chengdu, Sichuan 611130, China;2. Accounting and Finance Department, College of Business & Public Policy, University of Alaska Anchorage, Anchorage, AK 99508-4614, USA;3. Research Institute of Economics and Management, Southwestern University of Finance and Economics, Wenjiang District, Chengdu, Sichuan 611130, China |
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| Abstract: | The study affords comprehensive evidence of shock and volatility interactions between stock markets of each of the twenty four frontier markets and the U.S. for the period 2006:01 to 2015:07. The results from the recent EDCC-GARCH model of Nakatani and Teräsvirta (2009), which permits for concurrent estimation of shock and volatility interactions as well as dynamic conditional correlations (DCC) across assets, shows unidirectional shock and volatility transmissions from the U.S. to the frontier markets. The conditional correlation between the U.S. and each frontier market is very low or negative, offering diversification benefits to U.S. investors. The DCC exhibits slow decay and is insignificantly impacted by previous period's shocks. The results are very intuitive for optimal portfolio allocations using the traditional capital-based as well as the risk-based allocations. The risk parity approach to portfolio management increases (reduces) allocations to lower (higher) risk assets to improve portfolio diversification while increasing the risk-adjusted returns. |
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