Return and Volatility Spillovers: An Evaluation of India's Demonetization Policy

Abstract

We investigate the evolution of dynamic interactions among five major financial assets in the Indian economy, which its recent demonetization policy tried to influence. Spillovers account for more than 25 percent of the forecast error variance in all the five markets. In terms of total spillovers, the banking and the real estate sectors matter the most for the Indian economy. Gold market is responsible for the highest net volatility spillovers to other markets. Spillovers show major trends and cycles in their time series plots. The US economy transmits shocks directly to the key sectors of the Indian economy and via the gold and the foreign exchange markets. The events such as the election of the National Democratic Alliance government in India and the Indian government’s demonetization exercise were contemporaneous to some of the major episodes of return and volatility spillovers in the analyzed assets. The increased regulatory risk for the Indian IT sector post India’s demonetization policy and President Trump’s election seems to have increased the importance of the IT sector for gold and banking sector volatility shock transmission.