Jump Spillover and Risk Effects on Excess Returns in the United States During the Great Recession

Abstract

In this chapter, we review econometric methodology that is used to test for jumps and to decompose realized volatility into continuous and jump components. In order to illustrate how to implement the methods discussed, we also present the results of an empirical analysis in which we separate continuous asset return variation and finite activity jump variation from excess returns on various US market sector exchange traded funds (ETFs), during and around the Great Recession of 2008. Our objective is to characterize the financial contagion that was present during one of the greatest financial crises in US history. In particular, we study how shocks, as measured by jumps, propagate through nine different market sectors. One element of our analysis involves the investigation of causal linkages associated with jumps (via use of vector autoregressions), and another involves the examination of the predictive content of jumps for excess returns. We find that as early as 2006, jump spillover effects became more pronounced in the markets. We also observe that jumps had a significant effect on excess returns during 2008 and 2009; but not in the years before and after the recession.