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Volatility contagion: new evidence from market pricing of volatility risk

Marek Raczko ()

No 552, Bank of England working papers from Bank of England

Abstract: This paper proposes a novel approach to assessing volatility contagion across equity markets. I decompose the variance risk premia of three major stock indices into: crash and non-crash risk components and analyse their cross-market correlations. I find that crash-risk premia exhibit higher correlations than non-crash risk premia, implying the existence of volatility contagion. This suggests that investors believe that equity returns will be more highly correlated across countries during market crashes than during more normal times. The main result of the analysis holds when I apply other measures of co-movement as well as when I allow correlation to be time varying. Moreover I document that crash-premia constitute a large portion of the overall variance risk premia, highlighting the importance of crash-risks. Unlike the existing literature, my approach to testing the existence of volatility contagion does not rely on short periods of financial distress, but allows for crash-risk premia to be computed in tranquil times.

Keywords: Financial contagion; variance risk premium; tail-risk; equity co-movement; volatility co-movement (search for similar items in EconPapers)
JEL-codes: C58 F36 G12 G13 G15 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2015-09-29
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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