Risk Spillover during the COVID-19 Global Pandemic and Portfolio Management

Mohamed Yousfi,Houssam Bouzgarrou,Abderrazak Dhaoui

doi:10.3390/jrfm14050222

Mohamed Yousfi, Houssam Bouzgarrou + Show 1 more

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https://doi.org/10.3390/jrfm14050222

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Abstract

This paper aims to examine the volatility spillover, diversification benefits, and hedge ratios between U.S. stock markets and different financial variables and commodities during the pre-COVID-19 and COVID-19 crisis, using daily data and multivariate GARCH models. Our results indicate that the risk spillover has reached the highest level during the COVID-19 period, compared to the pre-COVID period, which means that the COVID-19 pandemic enforced the risk spillover between U.S. stock markets and the remains assets. We confirm the economic benefit of diversification in both tranquil and crisis periods (e.g., a negative dynamic conditional correlation between the VIX and SP500). Moreover, the hedging analysis exhibits that the Dow Jones Islamic has the highest hedging effectiveness either before or during the recent COVID19 crisis, offering better resistance to uncertainty caused by unpredictable turmoil such as the COVID19 outbreak. Our finding may have some implications for portfolio managers and investors to reduce their exposure to the risk in their portfolio construction.

Highlights

Nowadays, we experience a new type of crisis with a non-economic and financial origin: the pandemic COVID-19 health crisis
The GO-GARCH model is estimated with AR (1) in the mean equation and with a multivariate negative affine Gaussian distribution (MANIG), it is more appropriate than the multivariate t distribution
We find that the dynamic conditional correlation between all return pairs fluctuates greatly during our sample period, which indicate that portfolio managers and investors should adjust their portfolio structure frequently

Summary

Introduction

We experience a new type of crisis with a non-economic and financial origin: the pandemic COVID-19 health crisis. 19 pandemic, it comes as no surprise that Chinese financial markets acted as the epicenter of both physical and financial contagion (Corbet et al 2020a; Yousfi et al 2021) This new crisis has hard economic and financial consequences. Akhtaruzzaman et al (2020) examined contagion transmission through both financial and nonfinancial firms between China and the G7 countries over the COVID-19 crisis using the DCC model. They find more spillovers transmitted from China and Japan than that they receive. Financial firms are more affected by the sanitary crisis and are more prominent in spreading contagion compared to their nonfinancial competitors They observed a sharp increase in hedging costs during the COVID-19 crisis to optimize portfolios. They observed a sharp increase in hedging costs during the COVID-19 crisis to optimize portfolios. Corbet et al (2020b) explored the existence of sharp, dynamic, and new correlations between companies related to the term “corona”

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