Modelling dynamic financial linkages, spillover effects and volatility transmissions: empirical evidence from China and international financial markets
Creators: name: Huo, Rui
Publisher: name: RMIT University
Year: 2024
Subjects: classificationCode: 350202
subject: Finance
classificationCode: 350203
subject: Financial econometrics
classificationCode: 380205
subject: Time-series analysis

description: Over the last two decades, there has been a considerable change in the economic performance of China, making it the world’s most powerful emerging market and the second largest economy in the world. China’s stock market is now well developed and strongly influenced by global economic factors, regional financial development in Asia and local economic growth in China. Many crucial economic and financial reforms have been implemented, making the Chinese stock market more open to the world. Two well-established stock exchanges, based in Shanghai and Shenzhen are now operating with significant interdependence with other financial markets around the world.<br><br>The degree of market co-movements is an essential factor for determining the diversification opportunities across different financial markets. International stock market linkages have been extensively examined by empirical literature, suggesting that financial market integration is able to influence market co-movements. Given the increased market integration between China and other financial markets, this thesis investigates the dynamic financial linkages, spillover effects and volatility transmissions among different financial markets within China and between China and global markets, as strong interdependence among financial markets could lead to higher exposure to contagious effects when one market experiences a serious crash. Furthermore, this study also provides important practical implications for investors, portfolio managers and policy-makers based on the empirical findings.<br><br>The primary objective of this study is to investigate the nature and extent of market interdependence among the Chinese stock markets, the Chinese financial derivative markets and international stock markets. Various advanced econometrical models, including Vector Autoregression (VAR) models and Generalised Autoregressive Conditional Heteroscedasticity (GARCH) models, will be used to explore both return and volatility transmission mechanisms between different financial markets from China’s perspective. In order to achieve the key objective, this study conducts four inter-related research undertakings as follows: 1. An examination of spillover effect between the Shanghai and Hong Kong stock markets while evaluating the impact of the recently introduced Shanghai-Hong Kong Stock Connect; 2. An investigation of financial linkages, information transmission and market co-movement in the Asia-Pacific region; 3. The work further considers dynamic relationships between the Chinese stock market and its index futures market while evaluating the influence of Qualified Foreign Institutional Investors (QFII) scheme; and 4. An evaluation of dynamic spillovers among global oil price, equity and commodity markets in the Chinese region.<br><br>The purpose of the first empirical focus is to investigate the impact of Shanghai-Hong Kong Stock Connect by analysing the dynamic interdependence between the Shanghai and Hong Kong stock markets. High-frequency data are used to deeply examine the price movement and volatility behaviours of the two markets. The newly introduced Stock Connect initiative contributes to the increasing importance of the Chinese mainland stock market. Particularly, the increased conditional variances in both stock markets together with a weak and unstable cointegration relationship are observed following the introduction of Stock Connect. The observed strengthened volatility spillover effect from Shanghai to Hong Kong indicates a leading role of the former over the latter after this financial liberalisation reform. Overall, the empirical results suggest that the opening of Chinese mainland stock market could enhance the leading power, influence the risk level and improve the market efficiency of the Shanghai stock market. The success of the Shanghai-Hong Kong Stock Connect initiative provides valuable operational experience for the forthcoming Shenzhen-Hong Kong Stock Connect. In this way, the Chinese government should continue liberalising its financial markets to improve their market efficiency.<br><br>In the second empirical study, the price and volatility dynamics between China and major stock markets in the Asia-Pacific region around the Chinese stock market crash of 2015-2016 are analysed. Based on our estimation results of the Bayesian VAR and BEKK GARCH models, this study finds that price and volatility spillover behaviours are different during stable and stress periods. In particular, price spillovers from China to other regional markets are more significant during a bullish period, showing that ‘good news’ emanating from China has stronger impacts on its neighbours when China’s market increases. In the turbulent period, strong shock spillover effects from China to most Asia-Pacific stock markets and the enhanced volatility spillovers from China to the Asia-Pacific region are observed, implying an increasing degree of market interdependence across regional markets and the importance of China as a strategic financial centre in the region. The Asia-Pacific stock markets are also found to spill over their shocks to China during the crisis, showing that China is becoming more integrated with the regional financial markets.<br><br>The impact of the Qualified Foreign Institutional Investors (QFII) reforms on the dynamic relationship between the Chinese stock index futures and spot markets is further examined. 5 minutes high-frequency data together with various dynamic methods including VECM, GJR, BEKK and DCC GARCH models are employed to investigate the price discovery role and volatility spillover effect. This study finds a bi-directional asymmetric lead-lag relationship between the Chinese stock index futures and its underlying markets, indicating the futures market leads the spot market significantly, but there is a weak lead from the spot market to the futures market from the perspectives of both magnitude and lasting time. It is observed that the introduction of the QFII has enhanced the price discovery role of the futures market and increased the predictive power of the futures market. In addition, the Chinese stock index futures market is found to become less volatile (risky) and probably more efficient after the introduction of QFII. The enhanced volatility spillover effect from the futures market to the spot market is evident after the participation of foreign institutional investors in trading stock index futures contracts, suggesting an improvement in information transmission running from the futures to the spot market. The dynamic conditional correlation between the futures and spot markets decreases and becomes more volatile after the introduction of QFII, implying that the futures and spot markets become less correlated after the QFII.<br><br>Finally, the thesis provides a comprehensive analysis of dynamic spillover effects among the Chinese stock market, the Chinese commodity market and international oil market. Using a trivariate VAR-BEKK-GARCH model to estimate market volatility and its interactions, this study finds significant uni-directional return spillover effect from oil market to stock market, suggesting a strong dependence of the Chinese stock market on the oil market. The analysis results also indicate significant uni-directional return interaction from the Chinese stock market and global oil market to some key commodities in China. In particular, significant return contagions from the Chinese stock market to copper and aluminium futures and from oil market to silver, copper and aluminium markets are observed. The non-existence of return spillovers between gold and stock (oil) suggests the safe-haven role of the gold. In terms of the volatility spillovers, this study finds bi-directional shocks spillovers between oil and stock markets but uni-directional volatility spillovers from the oil market to the Chinese stock market. For commodities, the results show evidence of strong uni-directional shock and volatility spillovers from the stock market or oil market to some commodities. However, there are no spillover effects from all the commodity markets to either the stock market or oil market, meaning there are potential diversification benefits from the Chinese commodity markets. Finally, important implications for portfolio management and hedge strategy are provided.<br><br>This research makes significant contributions to the empirical literature on the financial linkages and volatility transmissions by empirically examining the influence of several important Chinese financial liberalisation reforms and comprehensively analysing the dynamic interdependence between the Chinese stock market and its interrelated financial markets. Since understanding information transmission between financial markets is critical for both market participants and policy-makers, the results of this thesis will help to facilitate an enhanced understanding of information transmission mechanism and risk contagions. As volatility contagions greatly affect smooth functioning and economic viability of financial markets which are the major concerns of investors and policy-makers, therefore a better understanding of the drivers and origins of market volatility can assist them in the decision-making process.<br><br>Policy-makers may also use this information to introduce new financial instruments, propose prudent financial regulations and implement policy tools in a timely manner. In addition, important practical implications can also be drawn from this thesis. As the findings of this thesis indicate more integration between the Chinese stock market and other markets, these markets have become more interdependent and improved their efficiency in terms of market information transmission. In addition, the increased level of financial integration also underpins cross-borders capital flow and international investment which are key drivers of local economic growth and fosters international risk management for portfolio optimisation. Consequently, it is suggested that investors and policy-makers actively monitor market movement and the degree to which China’s financial market is integrated. This will make it possible to predict future returns and volatility of other inter-related markets.<br>