Time-Varying Financial Spillovers from the US to Frontier Markets

Abstract

We examine US stock index return and volatility spillovers on the mean and volatility of stock index returns of 21 Frontier markets. We entertain potential time-variation in spillovers in mean returns by considering a time-varying parameter (TVP) model. Spillovers in volatility are modeled by augmenting a standard GARCH(1,1) model with current and one-period lagged US conditional volatility effects. The resulting model can be cast in state space form. However, it is not time-invariant as the 'coefficient' multiplying the state variable (the TVP parameter) is current period US returns. The model is estimated by the Kalman Filter. Our TVP model detects statistically significant time-variation in return spillovers and statistically and quantitatively important volatility spillovers for most Frontier markets. Several important hypotheses of interest are tested using a variety of restricted versions of the general model. Perhaps not surprisingly, Frontier countries are characterized as neither completely segmented nor completely integrated. An important contribution of the paper is a detailed analysis of the relative contributions from US and own-country lagged effects on both the mean and volatility of returns in Frontier countries. Our results indicate possible orthogonality in the contribution of current US and lagged own-country returns on Frontier countries mean returns.