Cross-market Correlations Research Articles

Financial Market Responses to the Policy Language of Forward Guidance: Evidence from China

Forward guidance is an innovative unconventional monetary policy tool used to manage expectations. This study not only investigates whether and how forward guidance influences financial markets but also explores its impact on cross-market correlations. Three key findings include: (1) larger absolute change in tone increases currency market volatility but decreases treasury bond and stock market volatilities. The noise-reducing effect is primarily attributable to forward guidance on economic outlook rather than policy inclination, although their effectiveness has reversed since 2015. (2) A positive change in forward guidance tone decreases currency market interest rate, which is economically negligible, albeit statistically significant. Returns of other financial assets are not responsive to the change in forward guidance tone. (3) Forward guidance significantly influences cross-market correlations though the impacts show heterogeneity. Economic-outlook and policy-inclination forward guidance significantly affect the currency-bond correlation in the same direction while exert differential impacts on bond-stock and currency-stock correlations. Two important implications for expectation management are enhancing coordination between different types of forward guidance as well as improving the efficiency of information transmission in communication.

Dynamic Linkages Between U.S and Indian Equity Markets: An Empirical Study

In this study, we investigate the dynamic linkages between US and Indian equity markets by examining the daily Total Return Index values of NIFTY 50 and NASDAQ Composite over a decade ending October 2024. While the indices are not found to be cointegrated, suggesting potential long-term diversification benefits, they exhibit significant short-term correlations. Through various statistical analyses including regression, correlation, and variance tests, we find strong positive associations between the markets, with NASDAQ Composite movements explaining approximately 89% of variations in NIFTY 50 Total Return Index (TRI). The study reveals distinct volatility patterns, with the Indian market showing higher price fluctuations but stronger absolute growth compared to its US counterpart. Despite the strong correlation, both markets maintain unique characteristics influenced by their respective economic fundamentals. The findings demonstrate the evolving nature of market integration between developed and emerging economies, offering valuable insights for international portfolio diversification strategies and risk management in an increasingly interconnected global financial system. Keywords: Market Integration, Volatility Spillover, Portfolio Diversification, Stock Market Returns, Emerging Markets, Cross-market Correlation

What drives cross-market correlations during the United States Q.E.?

This paper investigates the dynamic cross-market correlations and its crucial drivers between the United States (U.S.) stock and currency market and foreign markets during the U.S. Quantitative Easing (QE) periods. We focus on countries with strong trade and financial linkages with the U.S., including Australia, Canada, and Mexico. Our empirical analyses deliver important findings. First, we consistently find positive (negative) correlations between the U.S. equity (currency) market and financial assets of the three foreign countries under the scenario of the U.S. QE. Second, the magnitude of the conditional correlations tends to be strengthened during the initiation of the U.S. QE1 but was weakened during the U.S. QE3. Lastly, we find that U.S. treasury yields and term premium were among the most significant economic drivers of the markets' linkages during both QE1 and QE3 but in an opposite role. Meanwhile, the expected uncertainty in the bond market additionally contributed to drive the markets' interrelationship during the QE2. Our findings deliver important information to investors and policymakers to anticipate the dynamics of market linkages under U.S. QE scenarios.

Cross-Market Correlations and Financial Contagion from Developed to Emerging Economies: A Case of COVID-19 Pandemic

In the event that the COVID-19 pandemic spreads across various stock markets, this study may be deemed as one of the primary studies to evaluate cross-market interactions. The study examines the spread of contagious effects originating from developed economies (the United States, the United Kingdom, and Japan) to selected emerging markets (China, India, Thailand, Taiwan, Egypt, South Africa, Saudi Arabia, and the United Arab Emirates). The countries studied are classified into three regions: developed economies, Asia, and Africa and the Middle East. The crisis period is identified with the deployment of the Markov regime-switching model. The conditional correlations are compared before and after the crisis episode using the time-varying multivariate DCC-GARCH model. The findings confirm that certain emerging markets are experiencing contagion from developed markets, while others remain unaffected. Overall, investors in the two regions examined (Asia, and Africa and the Middle East) have comparable diversification options. The findings are expected to bolster policymakers and international agencies in developing post-crisis measures.

Liquidity commonality in sovereign bond markets

This paper documents commonality in the liquidity of sovereign bonds. We show that local market-level liquidity changes exert a substantial influence on the liquidity of single bonds. Unlike in equity markets there is only little evidence that changes in global liquidity affect the liquidity of individual sovereign bond markets. Instead, we document the occurrence of negative cross-market correlations of liquidity across several markets and time periods. The results further suggest that diverging monetary policy and the flight-to-safety phenomenon contribute to this decoupling in liquidity correlations.

MODELLING VOLATILITY SPILLOVERS, CROSS-MARKET CORRELATION AND CO-MOVEMENTS BETWEEN STOCK MARKETS IN EUROPEAN UNION: AN EMPIRICAL CASE STUDY

Purpose – This article examines volatility spillovers, cross-market correlation, and comovements between selected developed and former communist emerging stock markets in the European Union. Modelling the behavioural dynamics of European stock markets represents a vital topic in a fascinating context, but also a current challenge of great interest. Research Methodology – We propose to estimate and model volatility using GARCH family models for selected European markets. We aim to explore volatility movement, presence of leverage effect/ asymmetry in selected financial markets. Findings – The econometric approach includes GARCH (1, 1) models for the sample period from 1, January 2000 to 12, July 2018. The empirical results revealed that exists a significant presence of volatility clustering in all selected financial markets except Poland and Croatia. The empirical analysis also indicates that both recent and past news generate a considerable impact on present volatility. Research limitations – Our empirical study has certain limitations regarding the relatively small number of only eight stock markets. Practical implications – It can provide a useful perspective for researchers, academics, investors, investment managers, decision-makers, and scientists. Originality/Value – The empirical analysis is focused on 8 European stock markets, which are classified as developed (Spain, UK, Germany, and France) and emerging (Poland, Hungary, Croatia, and Romania).

The ‘Necessary Evil’ in Chinese Commodity Markets

Enormous capital inflows into the emerging commodity futures markets in China raised concerns about the impact of speculation. Using a broad sample of 30 commodities across sectors, this paper investigates whether the increased presence of speculators in recent years destabilizes the commodities market in China. In a portfolio framework, we find that increased speculation does not give rise to higher volatilities, elevate the cross-market correlations, nor distort the market’s association with economic fundamentals. Consistent with the literature, long-short speculators contribute positively to the price discovery by reducing the broad market volatility and cross-correlation with stocks. Overall, the cross-speculative pressure remains relatively low, and the increased speculation does not cause seemingly unrelated commodities to become correlated.

The “necessary evil” in Chinese commodity markets

Enormous capital inflows into the emerging commodity futures markets in China raised concerns about the impact of speculation. Using a broad sample of 30 commodities across sectors, this paper investigates whether the increased presence of speculators in recent years destabilizes the commodities market in China. In a portfolio framework, we find that increased speculation does not give rise to higher volatilities, elevate the cross-market correlations, nor distort the market’s association with economic fundamentals. Consistent with the literature, long-short speculators contribute positively to the price discovery by reducing the broad market volatility and cross-correlation with stocks. Overall, the cross-speculative pressure remains relatively low, and the increased speculation does not cause seemingly unrelated commodities to become correlated.

Did The Global Financial Crisis Alter Cross-market Correlation? A Copula-GARCH Approach

This paper uses a wide variety of copulas to study the correlation between the US market and a sample composed of nine developed and emerging markets over a 13 years period, including the subprime crisis. We try to analyze the markets behavior during high volatility periods and assess if the financial crisis led to a significant and durable change in the cross-market correlation patterns. Results offer strong evidence in favor of a contagion effect. Developed markets are those who registered the most important increases in cross-market correlations during high volatility periods. This may be attributed to their high degree of financial integration. However, cross-market correlation is weak for the whole sample period and decreased during the post-crisis period, implying that international diversification still offers interesting opportunities for investors. Moreover, diversification opportunities are not restricted to emerging markets but also concern developed markets.

Did Globalization Kill Contagion?

Does financial globalization lead to contagion? We scrutinize linkages between international stock markets in a long historical perspective (1880-2014). Our results highlight that without globalization, contagion cannot exist. However, if cross-market correlations are very high, globalization kills contagion. We show that financial contagion was absent from stock markets in both the period of deglobalization of 1918-1971 and the era of extreme globalization of 1972-2014 but was present in the period of globalization of 1880-1914. Our results suggest that contagion could become a significant problem if financial markets return to a more moderate level of globalization.

Exchange rate regimes and market integration: evidence from the dynamic relations between renminbi onshore and offshore markets

The Chinese renminbi (RMB) has been on the way of becoming a major international currency. This paper examines the impact of the RMB exchange rate regime and policy on the integration and information flows between RMB onshore and offshore markets. We employ a long sample of daily data encompassing multiple times of RMB exchange rate regime change (peg to managed float in 2005, re-peg in 2008, re-float in 2010, and the central parity reform in 2015), and study the dynamic conditional correlations and spillovers between RMB onshore spot market and offshore non-deliverable forward (NDF) market. It is found that the switch from exchange rate peg to managed float and a widening of the floating band strengthen cross-market correlation and information flows (especially offshore-to-onshore spillovers). A market-learning explanation is offered for the observation that the correlation collapse in the re-peg period was not as prompt as the correlation take-off in the 2005 reform period. These findings have important implications for China’s monetary and foreign exchange policies and shed light on the integration of China’s financial markets with the rest of the world.

ECB’s unconventional monetary policy and cross-financial-market correlation dynamics

This paper examines the effects of the unconventional monetary policy (UMP) launched by the European Central Bank on the cross-market correlations between bond, stock and currency forward markets. Using a dynamic conditional correlation analysis and several robustness tests, we investigate possible differences on the correlation dynamics across four UMP periods and across a range of developed countries and emerging market economies. The empirical results indicate a spillover effect on both developed and emerging markets, although this impact is not identical across assets and countries. We also find that the new UMP phase started in 2014 has a more prominent impact, highlighting differences on the impact between the earlier and the new wave of UMPs and across cross-market correlations.

Modelling Financial Contagion in the South African Equity Markets Following the Subprime Crisis

This paper used wavelet analysis and Dynamic Conditional Correlations model derived from the Multivariate Autoregressive Conditional Heteroskedasticity (MGARCH-DCC) to investigate the possible presence of financial contagion in the South African equity market in the wake of the subprime crisis that occurred in the United States. The study uses Dornbusch, Park and Claessens’s (2000) broader definition which asserts that financial contagion only takes place if cross-correlation between two markets is relatively low during the tranquil period, and that a crisis in one market results in a substantial increase cross-market correlation. Using wavelet analysis, the study found high levels of correlation during the subprime financial crisis in both smaller and longer timescales. In the former, high correlation was identified as financial contagion, whereas in the latter it was found to indicate co-movement due to financial fundamentals. The high correlation was identified for small scales 3, 4 and 5 that range from a week to one month indicates the presence of contagion. The study also used the MGARCH-DCC model to compare the cross-market correlation between the SA and the US markets, during a ‘pre-crisis’ and ‘crisis’ period. The study used data for the period between January 2005 and December 2007 for the ‘pre-crisis’ period and that for the period from January 2008 to December 2014 for the ‘crisis’ period. The results indicate cross-market linkages only during the crisis period; hence, it was concluded that cross-market correlation during the period of financial turmoil in the US was the result of financial contagion.

Testing for contagion in economic literature

The contagion of the financial crisis is an unavoidable fact for the economies of the global system anymore. Therefore measuring contagion, analyzing the propagation of volatility across countries became mainly important research topics among economists. There are many different econometric techniques used to test for contagion effect of financial crises. Transmission of shocks from one country to another can be calculated with four different techniques. The empirical literature mostly based on the techniques of measuring cross-market correlations, GARCH models, cointegration and probit models. In these models, economists use financial or real indicators or both of them in their analyses. As the financial indicators, they generally use share price indices, interest rates, exchange rates, and inflation rate. As the real indicators, they generally use the values of GDP, imports, exports, unemployment rate, etc. The aim of this paper is to underline the prominent empirical studies in the field of contagious crises

A systematic review of sovereign connectedness on emerging economies

This article systematically reviews the academic literature on emerging market contagion in order to summarize what we have learnt about the transmission channels existing in these countries. Given the large body of academic research focused on this topic, we especially direct our attention to the strand of the literature that defines and empirically analyses this topic as the significant increase in the cross-market correlations between asset returns during crisis periods or when a shock occurs. The survey covers the findings on financial contagion in the stock, bond, exchange and credit default swap markets during a large period that covers several crises that have characterized the related literature, such as the currency crises of the 1990s, the global financial crisis and the Eurozone debt crisis. Finally, new topics are identified, serving as an outline for future research.

Jumps in commodity markets

This paper investigates price jumps in commodity markets. We find that jumps are rare and extreme events but occur less frequently than in stock markets. Nonetheless, jump correlations across commodities can be high depending on the commodity sectors. Energy, metal and grains commodities show high jump correlations while jumps of meats and softs commodities are barely correlated. Looking at cross-market correlations, we find that returns of commodities co-move with the stock market, while jumps can be diversified. Most commodities are strong hedges for U.S. Dollar returns but weak hedges for U.S. Dollar jumps. Most commodities act as both return and jump hedges for Treasury notes.

International equity markets interdependence: bigger shocks or contagion in the 21st century?

We investigate the nature of shocks across international equity markets and evaluate the shifts in their comovements at business-cycle frequency. By using a parsimonious “identification through heteroskedasticity” methodology, we compute the impact exposures of index returns to common and country-specific shocks. We then establish some key results regarding comovement amongst international returns and macroeconomic fluctuations over the last decades. First, across all indices, persistent spells of high-volatility and high cross-market correlation always coincide with macroeconomic slowdowns and with measured shifts in macroeconomic and financial uncertainty. Second, there is a rise in the observed responses of international stock returns to common shocks during turbulent periods; however, such increase is largely attributable to bigger shocks (heteroskedasticity of fundamentals) rather than to breaks in the transmission mechanism or increased structural interdependence between markets. This holds for the Great Financial Crisis too. Third, since around the turn of the millennium, returns have more often experienced high volatility and comovement, likely because of larger and persistent macroeconomic disturbances.

A policymaker’s dilemma: real linkages or irrational behaviors?

PurposeThis paper aims to test whether the latest global financial crisis propagated contagiously from the USA to the rest of the world.Design/methodology/approachIf the reason of the propagation of a crisis is a normal time interdependence with the crisis origin country due to real linkages, the spread of crisis can be limited by implementing well-defined preventive policies. On the other hand, if a crisis propagates because of the speculative attacks or irrational behaviors, the “national policymakers will face difficulties in protecting their markets from such a crisis” (Kleimeier et al., 2003, p. 2). Therefore, separation of contagion and interdependence may provide crucial insights for policymakers to implement appropriate policies to prevent and/or stop the financial crisis. Hence, this paper compares the heteroscedasticity-corrected conditional correlations and dynamic conditional correlations in the tranquil and shock periods.FindingsThe findings were quite straightforward and consistent for both Forbes and Rigobon heteroscedasticity correction technique and dynamic conditional correlation (DCC) model. The Forbes and Rigobon technique failed to reject the null of no contagion for 25 countries in our data sample, while the DCC model failed to reject the null of no contagion for 21 countries. While heteroscedasticity-corrected correlation technique confirmed the presence of a contagion for six countries, the DCC technique confirmed the presence of a contagion for ten countries.Originality/valueThis study particularly investigates whether the subprime mortgage crisis spilled over contagiously to the rest of the world. To investigate whether there is a significant increase in the cross-market correlations between the crisis origin country, the USA and the rest of the world markets during the latest financial crisis, both heteroscedasticity-corrected correlation technique and DCC model are used.Therefore, this study possibly contributes well to the literature using a large country set and conducting the analysis from different angles for important properties.

Contagion in International Stock Markets After the Subprime Mortgage Crisis

The study focuses on utilizing a modified heteroskedasticity biased test for contagion based on cross-market correlation coefficients proposed by Forbes and Rigobon (2002) to find the evidence of contagion on 31 stock markets during the 2007 U.S. subprime mortgage turmoil. In contrast to the empirical results of Forbes and Rigobon (2002), which indicated that there was no contagion only interdependence during the 1997 Asian crisis, the 1994 Mexican peso devaluation, and the 1987 U.S. market crash, the empirical results demonstrate that the contagion occurred on emerging and East Asian stock markets during the 2007 U.S. subprime mortgage crisis. With extensions in the duration of the crisis, the contagion disappeared rapidly, and only the contagion occurred on the Brazilian stock market that lasted for six months.

The Cross-Section of Expected Returns in the Secondary Corporate Loan Market

We examine the pricing of characteristics and betas in the cross-section of expected corporate loan returns. Expected loan returns decrease with default beta. Default beta contains information not captured by rating or spread-to-maturity. A three-month formation momentum strategy earns a monthly premium of 122 bps. The effect is robust to various formation and holding periods, cannot be explained by other loan characteristics, and is prominent in loans issued by lowest-rated borrowers. We discover that portfolios including loser loans are riskier, but have lower returns. We find a cross-market correlation between loan and stock momentums. However, each contains additional independent information.