Volatility Spillovers across Major Equity Markets of Americas

ABSTRACTThis paper investigates the daily volatility spillovers between Standard and Poor's 500, and equity indices of Brazil, Argentina, and Mexico for the period of August 2007 through August 2012. We find that equity indices under study exhibit nonlinear dependencies, inconsistent with chaotic structure. Bivariate GARCH estimations indicate bi-directional spillovers. Findings show evidence of asymmetric market responses to shocks in all markets. Therefore, we estimate asymmetric bivariate EGARCH models. We find evidence of leverage effect as positive and negative shocks to each market impart unequal impact on the volatility of the other market. Furthermore, effects of negative shocks are much more pronounced than positive shocks. Finally, the non-linear Granger causality test results confirm that markets of Americas cause one another, i.e., there is shock feedback.JEL Classifications: G00, G15, G14Keywords: international volatility spillover; causality; shocks(ProQuest: ... denotes formulae omitted.)I. INTRODUCTIONThe world financial markets have experienced increasing integration, resulting in transmission of financial shocks across connected markets. Equity markets have felt the effects positive as well as negative shocks to economies and equity markets of all sizes around the world. While this is not a surprising outcome of economic and financial integration, the dynamics, the mode, and channels of contagion and shock transmission continue to be subjects of interest and investigation. Studying the spread of shocks, and financial crises throughout global economies, pique the interest of academicians, financial professionals, domestic and international regulators, and central bank policy makers. The consensus among researchers is that the globalization and expanding regional integration, through banking systems, international trade, and other cross investments have been instrumental in spreading economic and financial turmoil.Events of the decades of 1990s and 2000, as well as financial turmoil of Ireland, Greece, Portugal, and Spain in 2012-2013, demonstrate how economies of even small size can play a significant role in transmitting banking and equity market crises across world economies. Furthermore, these events have reignited interest in this line of research for all involved.Researchers have gone to great lengths to investigate the channels of contagion, shock transmission, and volatility spillovers among world major markets, in emerging markets, and between them. There are some obvious ramifications of the findings of such research. For instance, evidence of volatility spillovers and dynamics would offer an understanding on the degree of openness and economic co-dependence of global economies. Many emerging markets have implemented policies that have led to financial liberalization which has contributed to capital inflows. Increased capital flows into emerging market securities by portfolio managers and hedge funds have fueled renewed attention to these equity markets. Given that rates of economic growth in emerging markets dwarf those of developed economies, the attention given to them is understandable. Given that equity market returns and GDP growth rates are correlated, emerging market equities will only enter more fund portfolios.On the down side, concerns about the spread of financial crises from emerging markets have raised the risk of exposure to these economies. Portfolio managers want to understand the dynamic interactions between all equity markets, including emerging, in order to be able to evaluate market risk and hedging strategies. National and international regulators and central bankers need information and insight into these issues in order to be able to cope with spillovers of volatility, especially during the periods of financial crises. In particular, world's central bankers and other financial policy makers would benefit from this line of research findings may become better equipped to cope with contagious effects of shocks among markets. …