Abstract
In this paper, we are interested in detecting contagion from US to European stock market volatilities in the period immediately after the Lehman Brothers collapse. The analysis is based on a factor decomposition of the covariance matrix, in the time and frequency domain, using wavelets. The analysis aims to disentangle two components of volatility contagion (anticipated and unanticipated by the market). Once we focus on standardized factor loadings, the results show no evidence of contagion (from the US) in market expectations (coming from implied volatility) and evidence of unanticipated contagion (coming from the volatility risk premium) for almost any European country. Finally, the estimation of a three-factor model specification shows that a European common shock plays an important role in determining volatility co-movements mainly in the tranquil period, while in the period of financial turmoil, the US common shock is the main driver of volatility co-movements.
Highlights
In this paper we study implied and realized volatility co-movements, taking into account the long-memory properties of the series
2.2 Multivariate analysis: an introduction to multi-resolution analysis Once we have investigated the long memory properties of the implied volatility series, we turn our focus on multivariate analysis
Given the definition of financial contagion as a temporary, short-tem, phenomenon occurring during a period of financial turmoil, we investigate co-movements for investment time horizon between two and four days, between four and eight days and between eight and sixteen days
Summary
In this paper we study implied and realized volatility co-movements, taking into account the long-memory properties of the series. The studies of Baillie et al (1996), Andersen and Bollerslev (1997), Comte and Renault (1998) give evidence of long-run dependencies, described by a fractionally integrated process, in GARCH, realized volatilities, and stochastic volatility models, respectively. Bollerslev et al (2013) employ a co-fractional VAR to model long run and short run dynamics of realized variance, implied variance and stock return in the US market. In the first stage of the analysis we confirm (using daily data) the findings of Bandi and Perron (2006) regarding the existence of long memory in the level of implied and realized volatilities for the US, and for the European stock markets.
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