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Time-Varying General Dynamic Factor Models and the Measurement of Financial Connectedness

Matteo Barigozzi, Marc Hallin () and Stefano Soccorsi ()

No 257939806, Working Papers from Lancaster University Management School, Economics Department

Abstract: Ripple effects in financial markets associated with crashes, systemic risk and contagion are characterized by non-trivial lead-lag dynamics which is crucial for understanding how crises spread and, therefore, central in risk management. In the spirit of Diebold and Yilmaz (2014), we investigate connectedness among financial firms via an analysis of impulse response functions of adjusted intraday log-ranges to market shocks involving network theory methods. Motivated by overwhelming evidence that the interdependence structure of financial markets is varying over time, we are basing that analysis on the so-called time-varying General Dynamic Factor Model proposed by Eichler et al. (2011), which extends to the locally stationary context the framework developed by Forni et al. (2000) under stationarity assumptions. The estimation methods in Eichler et al. (2011), however, present the major drawback of involving two-sided filters which make it impossible to recover impulse response functions. We therefore introduce a novel approach extending to the time-varying context the one-sided method of Forni et al. (2017). The resulting estimators of time-varying impulse response functions are shown to be consistent, hence can be used in the analysis of (time-varying) connectedness. Our empirical analysis on a large and strongly comoving panel of intraday price ranges of US stocks indicates that large increases in mid to long-run connectedness are associated with the main financial turmoils.

Keywords: Dynamic factor models; volatility; financial crises; contagion; financial connectedness; high-dimensional time series; panel data; time-varying models; local stationarity (search for similar items in EconPapers)
JEL-codes: C32 C14 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-rmg
Date: 2019
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