An Empirical Analysis of the Volatility Spillover Effect between World-Leading and the Asian Stock Markets: Implications for Portfolio Management

Imran Yousaf,Wing-Keung Wong,Shoaib Ali

doi:10.3390/jrfm13100226

Abstract

This study employs the Vector Autoregressive-Generalized Autoregressive Conditional Heteroskedasticity (VAR-AGARCH) model to examine both return and volatility spillovers from the USA (developed) and China (Emerging) towards eight emerging Asian stock markets during the full sample period, the US financial crisis, and the Chinese Stock market crash. We also calculate the optimal weights and hedge ratios for the stock portfolios. Our results reveal that both return and volatility transmissions vary across the pairs of stock markets and the financial crises. More specifically, return spillover was observed from the US and China to the Asian stock markets during the US financial crisis and the Chinese stock market crash, and the volatility was transmitted from the USA to the majority of the Asian stock markets during the Chinese stock market crash. Additionally, volatility was transmitted from China to the majority of the Asian stock markets during the US financial crisis. The weights of American stocks in the Asia-US portfolios were found to be higher during the Chinese stock market crash than in the US financial crisis. For the majority of the Asia-China portfolios, the optimal weights of the Chinese stocks were almost equal during the Chinese stock market crash and the US financial crisis. Regarding hedge ratios, fewer US stocks were required to minimize the risk for Asian stock investors during the US financial crisis. In contrast, fewer Chinese stocks were needed to minimize the risk for Asian stock investors during the Chinese stock market crash. This study provides useful information to institutional investors, portfolio managers, and policymakers regarding optimal asset allocation and risk management.

Highlights

Information transmissions from both return and volatility across national equity markets are of greater interest to both investors and policymakers, with increasing financial integration in the stock markets all over the world (Yousaf et al 2020)
Our findings show that return spillover was observed from the US and China to the Asian stock market during the US financial crisis and the Chinese stock market crash
We extend the previous work by examining the return and volatility transmissions from the US and China to the eight emerging Asian stock markets including India, Indonesia, Korea, Malaysia, Pakistan, the Philippines, Taiwan, and Thailand during the Chinese stock market crash by using the VAR-AGARCH model

Summary

Introduction

Information transmissions from both return and volatility across national equity markets are of greater interest to both investors and policymakers, with increasing financial integration in the stock markets all over the world (Yousaf et al 2020). For example, asset volatility is transmitted from one market to another during turmoil or crisis period (Forbes and Rigobon 2002; Diebold and Yilmaz 2009), portfolio managers need to adjust their asset allocations (Baele 2005; Engle et al 2012) and financial policymakers need to adapt their policies in order to mitigate the contagion risk. Changes in linkages between national equity markets, especially during a crisis, can have important implications for asset allocations, business valuation, risk management, and access to finance. The CSI 300 index increased before reaching 5178 points in mid-June of 2015 It took a roller-coaster ride and dropped by up to 34% in just 20 days; Chinese stock market lost 1000 points within just one week. The Chinese stock market crash affected many other commodities and financial markets, including Asian (Allen 2015) and the US stock markets (The causes and consequences of China’s market crash 2015)

Methods

Results

Conclusion