How do normalization schemes affect net spillovers? A replication of the Diebold and Yilmaz (2012) study

Francesco Giuseppe Caloia, Andrea Cipollini and Silvia Muzzioli

Energy Economics, 2019, vol. 84, issue C

Abstract: This paper replicates the Diebold and Yilmaz (2012) study on the connectedness of the commodity market and three other financial markets: the stock market, the bond market, and the FX market, based on the Generalized Forecast Error Variance Decomposition, GEFVD. We show that the net spillover indices (of directional connectedness), used to assess the net contribution of one market to overall risk in the system, are sensitive to the normalization scheme applied to the GEFVD. We show that, considering data generating processes characterized by different degrees of persistence and covariance, a scalar-based normalization of the Generalized Forecast Error Variance Decomposition is preferable to the row normalization suggested by Diebold and Yilmaz since it yields net spillovers free of sign and ranking errors.

Keywords: Causality; Normalization schemes; Generalized forecast error variance decomposition; Spillover; Simulation; Vector autoregression models (search for similar items in EconPapers)
JEL-codes: C15 C53 C58 G17 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (26)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:84:y:2019:i:c:s0140988319303317

DOI: 10.1016/j.eneco.2019.104536

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