A Network Analysis of the Asia-Pacific and Other Developed Stock Markets: Pre and Post Global Financial Crisis

Abstract

This paper examines the volatility spillover and connectedness between Asia-Pacific, US, UK, and eurozone stock markets. A spillover index is built using forecast error variance decomposition in a vector autoregression framework and the spillover index is used to build network diagrams. It shows evidence of how the increase in risk transfer (volatility spillover) between the markets led to the global financial crisis and of the higher level of connectedness since. Network diagrams show the direction and strength of the connectedness. The network strength estimation enables us to understand the risk associated with connectedness across the markets in the event of a trigger and its influence in portfolio management decisions of international funds. The Chinese market appears to be the most insulated, while the South Korean, Hong Kong, and Singapore stock markets dominate in terms of risk transfer. The US, UK, EU, Singapore and Hong Kong are the top five volatility spillover recipient markets, both during pre and post global financial crisis periods. We find the market size to be irrelevant in the determination of the level of connectedness, whereas the role of geographical proximity cannot be ruled out. The findings are relevant to multinational investment strategies and in understanding the relative risk of investment in the Asia-Pacific region.