Greek Crisis, Stock Market Volatility and Exchange Rates in the European Monetary Union: A VAR-GARCH-Copula Model

Abstract

The main objectives of this study are twofold. The first objective is to examine the volatility spillover between seventeen European stock market returns and exchange rate, over the period 2007-2011, in a multivariate setting, using the VAR (1)-GARCH (1,1) model which allows for transmission in returns and volatility. The second is to investigate the dependence structure and to test the degree of the dependence between financial returns using two measures of dependence: correlations and copula functions. Five candidates, the Gaussian, the Student’s t, the Frank, the Clayton and the Gumbel copulas, are compared. Our empirical results for the first objective suggest that past own volatilities matter more than past shocks (news) and there are moderate cross market volatility transmission and shocks between the markets. Moreover, the result on the second objective implies that, considering all the financial returns together, the Student-t copula seems the best fitting model, followed by the Normal copula, both for the two sub-period. The dependence structure is symmetric and has non-zero tail dependence. However, if we examine the relationship between each pair of stock-FX returns, both of the degree of the dependence and the dependence structure vary when the financial Greek crisis occurs. Our findings have important implications for global investment risk management by taking into account joint tail risk.