Abstract
This paper studies the stock market return's volatility in the Eurozone as an input for evaluating the market risk. Stock market returns are endogenously determined by long-term interest rate changes and so is the return's conditional variance. The conditional variance is the time-dependent variance of the underlying variable. In other words, it is the variance of the returns measured at each moment t, so it changes through time depending on the specific market structure at each time observation. Thus, a multivariate EGARCH model is proposed to capture the complex nature of this network. By network, in this context, we mean the chain of stock exchanges that co-move and interact in such a way that a shock in one of them propagates up to the other ones (contagion). Previous studies provide evidence that the Eurozone stock exchanges are deeply integrated. The results indicate that asymmetry and leverage effects exist along with fat tails and endogeneity. In-sample and out-of-sample forecasting tests provide clear evidence that the multivariate EGARCH model performs better than the univariate counterpart to predict the behavior of returns both before and after the 2008 crisis.
Highlights
Many studies on stock market volatility use a univariate approach and/or are mostly concerned with modeling the mean parameters of the underlying distribution function
When the price of commodities tends to uniformity across markets it makes sense that financial returns play a greater role in the financial management of firms or other economic agents
The log conditional variance depends on the 10-year interest rate change and a set of six dummies for the post-crisis years
Summary
Many studies on stock market volatility use a univariate approach and/or are mostly concerned with modeling the mean parameters of the underlying distribution function. Understanding the variance effect and its evolution over time is a major research topic in financial markets, since the variance can provide important information about the asset’s risk and its evolution over time. If we can model simultaneously the mean and the variance effects the approach becomes even more informative and it works in a fully (or quasi-fully) endogenous framework. Published under licence by IOP Publishing Ltd. 2.1 Background As the globalization process deepens and the economic agents compete in worldwide markets, the internationalization of the financial sources is intensified. When the price of commodities tends to uniformity across markets it makes sense that financial returns play a greater role in the financial management of firms or other economic agents. Economic agents will tend to search for the most profitable financial sources at the lowest market risk. Assuming that the returns are exogenously and a priori determined, the investor will look, basically, at the risk
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