Volatility spillover between economic sectors in financial crisis prediction: Evidence spanning the great financial crisis and Covid-19 pandemic

Abstract

This paper measures volatility spillovers between sectors of economic activity using network connectivity measures. Volatility spillovers are an accurate proxy for the transmission of risk across sectors and are particularly informative during crisis periods. To do this, we apply the novel methodology proposed in Diebold and Yilmaz (2012) to seven economic sectors of U.S. economic activity and find that Banking&Insurance, Energy, Technology and Biotechnology are the main channels through which shocks propagate to the rest of the economy. Banking&Insurance is especially relevant during the 2007–2009 global financial crisis while the Energy sector and Technology are especially relevant during the COVID-19 crisis. We also show that volatility spillovers exhibit ability to predict high episodes of volatility for the S&P 500 index being useful as early financial crisis indicators.