Return Comovement Research Articles

Intensity of shock transmission amid US-BRICS markets

Purpose – The purpose of this paper is to analyze the intensity of transmission of shocks from USA to BRICS countries in the long-run and short-run deviations and swiftness of recovery during US subprime mortgage crisis. This analysis enables the authors to explore the evolving patterns of relationships between these markets and examine whether their co-movements altered either in response to international shocks that originated in advanced markets like USA or due to their domestic fluctuations. Design/methodology/approach – Employing data of daily stock market indices (open and close) of BRICS countries for the period January 2, 2001 to May 31, 2012, this paper examines the interactions and characteristics of price movements of BRICS with US market by applying co-integration tests, vector error correction model and Granger causality relationship. The daily stock market indices data are derived from respective stock exchange web sites. Findings – The results exhibit that both long-run co-integration relationships and short-run Granger causality relationships exist between the stock markets of US-BRICS. Furthermore, this nexus is amplified in the short-run during 2007-2009, when the subprime mortgage financial crisis in the USA cropped up. This finding lends support to the prominence of developed (US) market links in the proliferation of persistent co-movements of BRICS stock markets. Research limitations/implications – The findings imply an increasing degree of global market integration due to quick dissemination of global shocks originating from developed market like USA, and swift recovery which can be attributed to the increased resilience, consistent with the moderated level of domestically driven risk in the BRICS markets. In spite of their similarities, long-run and short-run interdependences with the US stock market exhibit differences among the BRICS. This can be attributed to the regional heterogeneity in long-run risk and return co-movements with the USA. Practical implications – Changes from the US index easily affect these stock markets in the short-run, which implies that the US index may act as a leading indicator for investing funds in BRICS markets. Originality/value – This study would enable the authors to understand whether BRICS economies actually remain resilient to adverse developments in USA and could serve as alternative investment destinations for global portfolio diversification.

Bank integration and co-movements across housing markets

This paper investigates whether bank integration measured by cross-border bank flows can capture the co-movements across housing markets in developed countries by using a spatial dynamic panel model. The transmission can occur through a global banking channel in which global banks intermediate wholesale funding to local banks. Changes in financial conditions are passed across borders through the banks’ balance-sheet exposure to credit, currency, maturity, and funding risks resulting in house price spillovers. While controlling for country-level and global factors, we find significant co-movement across housing markets of countries with proportionally high bank integration. Bank integration can better capture house price co-movements than other measures of economic integration. Once we account for bank exposure, other spatial linkages traditionally used to account for return co-movements across region – such as trade, foreign direct investment, portfolio investment, geographic proximity, etc. – become insignificant. Moreover, we find that the co-movement across housing markets decreases for countries with less developed mortgage markets characterized by fixed mortgage rate contracts, low limits of loan-to-value ratios and no mortgage equity withdrawal.

Skewness and Co-Skewness in Bond Returns

Bond skewness and coskewness (i.e., bond return comovement with market volatility) are both time varying, with cross-sectional variation driven by maturity and credit rating. Other things being equal, longer maturity bonds have lower skewness, and lower coskewness with respect to the bond market index; lower quality bonds have lower skewness, and higher coskewness with respect to the bond market index. Three-moment bond alphas (which account for coskewness effects) are time varying and predictable by market default spread. They are significantly different from, and often are closer to zero than, two-moment alphas (which ignore coskewness effects).

How would Eurozone equities respond to a bond sell-off?

Economic OutlookVolume 39, Issue 3 p. 18-24 Economic Outlook How would Eurozone equities respond to a bond sell-off?† First published: 12 August 2015 https://doi.org/10.1111/1468-0319.12165 † By Bronka Rzepkowski, PhD, Senior Economist, brzepkowski@oxfordeconomics.com AboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onFacebookTwitterLinkedInRedditWechat Abstract We have developed a new model to measure the impact on Eurozone equities of a global bond sell-off as the Fed starts to tighten its monetary stance later this year. We show that the most affected countries would be Greece, Finland and Portugal: the cumulated equity loss compared to the baseline ranges from between 35% to more than 50% in the case of Greece at the end of 2017. Under this scenario, Belgium, Ireland and Austria are less impacted by the global re-pricing of risk. In light of global risk being skewed to the downside (China, Greece, risk-off), it is essential to have a framework that is able to generate consistent responses of Eurozone stock indices to global macro shocks in stress test scenarios. The approach assesses first the co-movements of Eurozone stock indices and aims to explain them with macro variables such as the US S&P index, the oil price, the euro/dollar exchange rate and short- and long-term interest rate differentials between the Eurozone and the US. We find a high degree of co-movement in Eurozone equity returns. This matters from an asset management perspective, as it reveals limited potential for diversification benefits of an equity portfolio invested across Eurozone countries. Volume39, Issue3July 2015Pages 18-24 RelatedInformation

Do Index Futures and ETFs Affect Stock Return Correlations?

We examine both theoretically and empirically whether increased trading activity in index futures and exchange traded funds (ETFs) is associated with higher equity return correlations. Our model predicts that demand shocks to ETFs and futures lead to stronger price comovement for index stocks and non-index stocks. Moreover, demand shocks to ETFs have a higher impact on stock return correlations than shocks to futures. We confirm the model predictions by studying the correlation of U.S. stocks after the inception of S&P 500 futures and ETFs. Furthermore, our empirical results suggest that the return comovement induced by index trading is excessive.

Tail Dependence: A Cross-Industry Comparison

Tail dependence is a crucial element in assessing downside risk of industry portfolios. The authors measure tail dependence in the 48 industries by comparing comovements in extreme negative returns within these industries. The industries that score highest are banking, petroleum and natural gas, utilities, financial trading, and insurance. All other industries score significantly lower. The authors identify a large market beta, a large market cap, and low volatility as significant determinants of the tail dependence. In addition, tail dependence in one year is an important indicator for tail dependence in the next year. <b>TOPICS:</b>Tail risks, risk management

Dynamics of Bond and Stock Returns

I present a production-based general equilibrium model that jointly prices bond and stock returns. The model produces time-varying correlation between stock and long-term default-free real bond returns that changes in both magnitude and sign. The real term premium is also time-varying and changes sign. To generate these results, the model incorporates time-varying risk aversion within Epstein-Zin preferences and two physical technologies with different exposure to cash-flow risk. Bonds hedge risk-aversion (discount-rate) shocks and command negative term premium through this channel. Capital (cash-flow) shocks produce comovement of bond and stock returns and positive term premium. The relative strength of these two mechanisms varies over time.

The effects of domestic and international news and volatility on integration of Chinese stock markets with international stock markets

This paper provides a comprehensive and up-to-date analysis of time-varying return co-movements between Chinese stock markets and stock markets in the USA, UK, France and Japan by employing smooth transition conditional correlation (STCC-GARCH) and double smooth transition conditional correlation (DSTCC-GARCH) models with specific emphasis on the role of domestic and international news and volatility. Unlike earlier literature, we reveal that there are noticeable rising trends in conditional correlations among these markets particularly following the financial reforms in China. Moreover, the empirical results of DSTCC-GARCH specifications with time and various volatility measures generally indicate that the correlations increase, not only over time but also during calm periods, suggesting that Chinese stock markets may be safe harbors during global financial crisis.

Communication and Comovement: Evidence from Online Stock Forums

We study investor communication and stock comovement using a novel dataset for an active online stock forum in China. We find substantial comovement among the returns of a stock and its “related stocks,” that are frequently discussed in the sub-forum dedicated to the given stock. Comovement is greater when related stocks are more frequently discussed. Further, the effect of frequent communication on comovement is stronger for stocks associated with higher information asymmetry. We also use a forum outage event as a quasi-natural experiment to establish causality. Our findings highlight the impact of investor communication on stock return comovement.

Labor Market Peer Firms

I propose a new measure of firms’ economic linkages by analyzing employees’ internet co-search patterns on LinkedIn, a professional networking and corporate recruiting website. Labor market peer firms (LMPs) (1) overlap but differ from standard output-market-based industry groupings; (2) exhibit significant incremental power to explain stock return and earning comovements; (3) outperform standard industry groupings to explain return comovements when LMPs share more labor market skills with the base firm. My results highlight the potential of using employees’ collective wisdom - extracted from the internet - to measure input market linkages that are not identified by standard industry measures.

Virtual integration of financial markets: a dynamic correlation analysis of the creation of the Latin American Integrated Market

This article investigates the role of virtual integration of financial markets on stock market return co-movements. In May of 2011, the Chilean, Colombian and Peruvian stock markets virtually integrated their stock exchanges and central securities depositories to form the Latin American Integrated Market (MILA). We utilize the dynamic conditional correlation model proposed by Engle (2002) to identify a statistically significant positive correlation between these markets. Moreover, we find strong evidence that the creation of the MILA increased the levels of dynamic correlation between stock returns. A higher correlation was also found during the dot-com bubble and the 2007 financial crises. Our results imply a decline in gains from international diversification by holding portfolios consisting of diverse stocks of these countries.

Stock return commonality within business groups: Fundamentals or sentiment?

We examine stock return comovement within business groups in Korea. Based on all publicly traded stocks from 1980 to 2009, we document that stocks of companies belonging to the same business group co-move with each other more than do stocks in the same industry. The within-group correlation in excess of the within-industry correlation has become more pronounced over time, especially following the 1997–98 Asian crisis. The increase in correlation appears to be driven more by non-fundamental factors such as correlated trading, rather than fundamental factors such as related-party transactions. Our study adds to the literature by showing that non-fundamental stock return correlation – i.e., categorization or habitat-driven stock comovement – exists even at the business-group level.

Determinants of Systemically Important Banks: The Case of Europe

We investigate the drivers of systemic risk and contagion among European banks from 2007 to 2012. First, we derive a systemic risk measure from the concepts of MES and CoVaR analysing tail co-movements of daily bank stock returns. We then run panel regressions for our systemic risk measure using idiosyncratic bank characteristics and a set of country and policy control variables. Our results comprise highly significant drivers of systemic risk in the European banking sector with important implications for banking regulation.

A social-media-based approach to predicting stock comovement

Stock return comovement analysis is important to financial analysts, decision makers, and academic researchers and has many financial implications, such as portfolio management, style investing, and market risk detecting. This paper proposes a novel model to both identify homogeneous stock groups and predict stock comovement with respect to firm-specific social media metrics. One of the innovations of the social media platform is that it breaks traditional media intermediation. A firm with an official Twitter account can publish information and interact with its users directly. Such direct information is largely reflected on firm-specific metrics, e.g., the firm’s number of followers and number of tweets sent. To the best of our knowledge, this paper is the first to reveal the impact of social media metrics on stock return comovement studies. By analyzing samples from the NYSE and NASDAQ stock exchanges, we find that firms with official Twitter accounts have a much higher comovement than those without such accounts. Furthermore, we classify the former set of firms into homogeneous groups by their specific microblogging metrics. The results demonstrate that these metrics cannot only predict the comovement of stocks but also notably increase the accuracy of comovement predicting, compared with industry categories.

Volatility and co-movement: an analysis of stock markets behavior of selected emerging and developed countries

Financial markets around the world suffer significantly during the GFC and European debt crisis. Although the GFC is over, but the after-effect is still visible in most of the developed and emerging countries and stock markets remained volatile. In this paper, we analyse historical stock market volatility and co-movement behavior of three emerging markets and three developed economies from January 2001 to December 2012. We investigate whether the stock market volatilities and co-movement behaviors are correlated and affected by the GFC during the observation period. Our analysis of stock market behavior and co-movement analysis includes the standard historical volatility model and R-square estimates. We use the standard historical volatility model followed by Jones et al. (1998), Andersen and Bollerslev (1997) and Andersen and Bollerslev (1998); and the R-square metrics were suggested by Morck et al. (2000), Khandaker and Heaney (2009) and Alves et al. (2010). The selection criteria for the developed economies include geographical location, availability of stock return data and size of the equity market; and emerging markets are taken from the emerging Asian markets based on their recent market performance, growth rate and market capitalisation. We find evidence that the sample of emerging markets, exhibits higher stock market volatility during the sample period and these volatilities increases during the GFC. There is also evidence that the sample emerging countries exhibit a higher level of stock market co-movement behavior, and these markets were highly synchronous during the GFC. For example, China exhibits higher stock return co-movement behavior and, this behavior increase during the GFC. Further, we do not find any evidence of a statistically significant correlation coefficient between the volatility measures and stock return co-movement measures for our sample developed countries. However, these measures are statistically significant for the emerging country group. The example includes China and Malaysia. Our result provides evidence that stock market co-movement behavior or the R-squared matrix captures somewhat different aspects of stock market behavior other than the stock market volatility for the developed economies. Therefore, it is concluded that both these market models capture somewhat different aspects of stock market behavior and should be carefully used.

The Financialization of Food?

Commodity-equity return co-movements rose dramatically during the Great Recession. This development took place following what has been dubbed the “financialization” of commodity markets. We first document changes since 1995 in the relative importance of financial institutions’ activity in agricultural futures markets. We then use a structural VAR model to ascertain the role of that activity in explaining correlations between weekly grain, livestock, and equity returns in 1995-2015. We provide robust evidence that, accounting for shocks which are idiosyncratic to agricultural markets, world business cycle shocks have a substantial and long-lasting impact on the latter’s co-movements with financial markets. In contrast, changes in the intensity of financial speculation have an impact on cross-market return linkages that is shorter-lived and not statistically significant in all model specifications.

INTERNATIONAL STOCK MARKET COMOVEMENT AND NEWS

AbstractWe explore how news comovement drives a portion of stock return comovement using the Thomson Reuters international business news database. We develop a measure of news comovement similar in design to a well‐known measure of stock return comovement and find that news helps explain country‐level stock market comovement. Our results are novel in that we find that more news comovement is related to higher stock market comovement. The explanatory power of news comovement is found to be particularly strong in countries that have low total market capitalization, are more corrupt, and have lower accounting standards.

Co-movements in commodity prices: Global, sectoral and commodity-specific factors

This paper characterizes the co-movements in commodity prices with a dynamic latent factor model that decomposes commodity returns into global, sectoral, and idiosyncratic components. The results indicate that global and sectoral factors are important sources of co-movements in commodity returns. A sub-sample analysis further reveals that the global factor increases significantly in importance since 2004, which indicates an increasing integration among commodity markets.

Determinants of systemically important banks: the case of Europe

Purpose– This paper aims to investigate the drivers of systemic risk and contagion among European banks from 2007 to 2012. The authors explain why some banks are expected to contribute more to systemic events in the European financial system than others by analysing the tail co-movement of banks’ security prices.Design/methodology/approach– First, the authors derive a systemic risk measure from the concepts of marginal expected shortfall and conditional value at risk analysing tail co-movements of daily bank stock returns. The authors then run panel regressions for the systemic risk measure using idiosyncratic bank characteristics and a set of country and policy control variables.Findings– The results comprise highly significant drivers of systemic risk in the European banking sector with important implications for research and banking regulation. Using a set of panel regressions, the authors identify bank size, asset and income structure, loss and liquidity coverage, profitability and several macroeconomic conditions as drivers of systemic risk.Research limitations/implications– Analysing the tail co-movement of security prices excludes a number of “smaller” institutions without publicly listed securities. The other shortfall is that we do not assess the systemic impact of non-bank financial institutions.Practical implications– Regulators have to consider a broad variety of indicators for assessing systemic risks. Existing microprudential-oriented rules are less effective, and policymakers may consider new measures like asset diversification to mitigate systemic risks in the banking system.Originality/value– The authors contribute to existing empirical analyses in three ways. First, they propose a method to identify systemically important banks (SIBs). Second, they develop two measures to assess their potential negative impact on the system. Third, they contribute to the closing of the research gaps by analysing which macroprudential regulations for SIBs are most effective without hampering free market forces.

Commonality in news around the world

Motivated by the pioneering study of Morck, Yeung, and Yu (2000), this paper investigates whether and how news commonality varies according to a country׳s institutional environments. Using a unique global news data set across 41 countries for the 2000–2009 period, we document three notable findings. First, firm-level news comoves more in countries with weaker institutional environments than in those with stronger institutional environments. Second, news commonality is positively associated with both stock return comovement and stock liquidity commonality. Third, the effect of news commonality on stock return and liquidity comovement is higher in countries with stronger institutions than in those with weaker institutions. These results suggest that a country׳s institutional environments affect firm-specific information production and, more importantly, support the information-efficiency view that lower price synchronicity is caused by greater capitalization of firm-specific information.