Time-varying financial spillovers from the US to frontier markets
Galin Todorov and
Macroeconomics and Finance in Emerging Market Economies, 2014, vol. 7, issue 2, 246-283
We examine US stock index return and volatility spillovers on the mean and volatility of stock index returns of 21 Frontier markets. We entertain potential time variation in spillovers in mean returns by considering a time-varying parameter (TVP) model. Spillovers in volatility are modelled by augmenting a standard GARCH (1, 1) model with current and one-period lagged US conditional volatility effects. The resulting model can be cast in state space form. However, it is not time invariant as the 'coefficient' multiplying the state variable (the TVP parameter) is current period US returns. The model is estimated by the Kalman filter. Several important hypotheses of interest are tested using a variety of restricted versions of the general model. An important contribution of the paper is a detailed analysis of the relative contributions from US and own-country lagged effects on both the mean and the volatility of returns in Frontier countries. In summary, our TVP model detects statistically significant time variation in return spillovers, and statistically and quantitatively important volatility spillovers for most Frontier markets. However, the model captures only a small portion of their daily return fluctuations. Most Frontier markets display volatility that is greater both in magnitude and variability relative to the US. Time-varying and quantitatively significant spillovers from the US are important in 13 of the 21 Frontier countries. Quantitative or statistically significant impact of US conditional volatility is found for at least 14 markets. Our results strongly reject the polar null hypotheses of complete market segmentation or complete market integration. Thus, Frontier markets are characterized as neither completely segmented from the US nor completely integrated with it. Results further suggest possible orthogonality in the contributions of current US and lagged own-country returns on Frontier countries' mean returns.
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