Abstract
This paper analyses the volatility transmission between European Global Systemically Important Banks (GSIBs) and implied stock market volatility. A Dynamic Conditional Correlation Generalized Autoregressive Conditional Heteroskedasticity model is applied to determine the dynamic correlation between returns of Europe’s GSIBs and the world’s most prominent measure of market “fear”, the CBOE Volatility Index (VIX). The results identify a higher negative co-relationship between the VIX and GSIB returns during the COVID-19 period compared with the Global Financial Crisis (GFC), with one-day lagged changes in the VIX negatively Granger-causing bank returns. The asymmetric impact of changes in implied volatility is examined by quantile regressions, with the findings showing that in the lower quartile–where extreme negative bank returns are present–jumps in the VIX are highly significant. This effect is more pronounced during COVID-19 than during the GFC. Additional robustness analysis shows that these findings are consistent during the periods of the Swine Flu and Zika virus epidemics.
Highlights
The European banking sector is one of the world’s largest and is an integral part of the global financial system, while incorporating some of the world’s largest economies.1 Previous empirical research has highlighted the importance of risk management given potential contagion effects with banks both within and outside Europe (Gabrieli & Salakhova, 2019; Teply & Klinger, 2019)
The results identify a higher negative co-relationship between the Volatility Index (VIX) and Global Systematically Important Banks (GSIBs) returns during the COVID-19 period compared with the Global Financial Crisis (GFC), with one-day lagged changes in the VIX negatively Granger-causing bank returns
This effect is more pronounced during COVID-19 than during the GFC
Summary
The European banking sector is one of the world’s largest and is an integral part of the global financial system, while incorporating some of the world’s largest economies. Previous empirical research has highlighted the importance of risk management given potential contagion effects with banks both within and outside Europe (Gabrieli & Salakhova, 2019; Teply & Klinger, 2019). The European banking sector is one of the world’s largest and is an integral part of the global financial system, while incorporating some of the world’s largest economies.. We investigate the volatility impacts on the European banking sector, with specific attention to the COVID-19 crisis period. We add to recent work on volatility transmission within the banking industry more generally, as well as recent work on financial market impacts during the COVID-19 crisis (Claeys, 2020). A unique feature of this study is the identification of the time-varying correlation between implied stock market volatility and the largest European banks, defined by banking regulators as those that are Global Systemically Important Banks (GSIBs). The study compares patterns in transmission during the Global Financial Crisis between 2007 and 2009, and the COVID-19 period
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