Advertisement

DECISION

, Volume 45, Issue 4, pp 325–344 | Cite as

Domestic intermarket linkages: measuring dynamic return and volatility connectedness among Indian financial markets

  • Neharika SobtiEmail author
Research Article
  • 17 Downloads

Abstract

The dynamic functioning of the markets and increased economic and financial integration has made the world more vulnerable to systemic shocks emanating either domestically from cross-market connectedness or globally from cross-country connectedness. The study focuses on the former channel of transmission of shocks within a country (India) due to linkages among its five financial markets that are analysed using a widely adopted Connectedness measure of Diebold and Yilmaz (J Econom 182(1):119–134, 2014) which is based on weighted and directed network analysis of variance decomposition in a generalized VAR framework which is an improvement of the Diebold and Yilmaz (Econ J 119(534): 158–171, 2009, Int J Forecast 28(1):57–66, 2012) method. An attempt has been made to analyse the return and volatility connectedness among five financial markets in India: stock, bond, money, foreign exchange and commodity markets from 2006 to 2017. The purpose of this study is to examine the dynamic interrelationships among these five markets with an aim to demystify issues like which markets are major transmitters of shocks, which markets are more vulnerable to propagation of such shocks, which markets are ideal for hedging against these shocks and how to achieve portfolio diversification benefit within India. The study reveals that stock markets and foreign exchange market are the largest transmitter of shocks to return, while volatility connectedness analyses reveals that commodity market is the largest net volatility transmitter to other asset markets along with forex and stock markets. The bond and money markets in India remain largely insulated from domestic connectedness effects. Dynamic connectedness measure highlights that Indian asset markets are more vulnerable to internal shocks as domestic connectedness amplifies the effects of external shocks.

Keywords

Connectedness Intermarket linkages Return Volatility India 

JEL Classification

C58 F36 G11 G12 Q02 

References

  1. Abanomey WS, Mathur I (2001) International portfolios with commodity futures and currency forward contracts. J Invest 10(3):61–68CrossRefGoogle Scholar
  2. Acharya VV, Pedersen LH, Philippon T, Richardson MP (2010) Measuring systemic risk. Working paper, NYUGoogle Scholar
  3. Acharya V, Engle R, Richardson M (2012) Capital shortfall: a new approach to ranking and regulating systemic risks. Am Econ Rev 102(3):59–64CrossRefGoogle Scholar
  4. Andersen TG, Bollerslev T, Christoffersen PF, Diebold FX (2006) Practical Volatility and Correlation Modeling for Financial Market Risk Management. In: Carey M, Stulz R (eds) Risks of Financial Institutions, University of Chicago Press for NBER, pp 513–548Google Scholar
  5. Anderson TG (1996) Return volatility and trading volume: an information flow interpretation of stochastic volatility. J Finance.  https://doi.org/10.1111/j.1540-6261.1996.tb05206.x CrossRefGoogle Scholar
  6. Ankrim EM, Hensel CR (1993) Commodities in asset allocation: a real-asset alternative to real estate? Finance Anal J 49:20–29CrossRefGoogle Scholar
  7. Anson MJ (1999) Maximizing utility with commodity futures diversification. J Portfolio Manag 25(4):86–94CrossRefGoogle Scholar
  8. Antonakakis N, Gupta R, André C (2015) Dynamic co-movements between economic policy uncertainty and housing market returns. J Real Estate Portf Manag 21(1):53–60Google Scholar
  9. Arshanapalli B, d’Ouville E, Fabozzi F, Switzer L (2006) Macroeconomic news effects on conditional volatilities in the bond and stock markets. Appl Finan Econ 16(5):377–384CrossRefGoogle Scholar
  10. Bae K-H, Karolyi GA, Stulz RM (2003) A new approach to measuring financial contagion. Rev Financ Stud 16(3):717–763.  https://doi.org/10.1093/rfs/hhg012 CrossRefGoogle Scholar
  11. Balli F, Hajhoj HR, Basher SA, Ghassan HB (2015) An analysis of returns and volatility spillovers and their determinants in emerging Asian and Middle Eastern countries. Int Rev Econ Finance 39(140067):311–325.  https://doi.org/10.1016/j.iref.2015.04.013 CrossRefGoogle Scholar
  12. Batten JA, Ciner C, Lucey BM (2010) The macroeconomic determinants of volatility in precious metals markets. Resourc Policy 35(2):65–71.  https://doi.org/10.1016/j.resourpol.2009.12.002 CrossRefGoogle Scholar
  13. Becker CL, Defond ML, California S (1998) The effect of audit quality on earnings management. Contemp Account Res 15(1):1–24CrossRefGoogle Scholar
  14. Becker K, Finnerty J (2000) Indexed commodity futures and the risk and return of institutional portfolios. Office of Futures and Options Research, Working paperGoogle Scholar
  15. Bekaert G (1995) Market integration and investment Barriers in emerging equity markets. World Bank Econ Rev 9(1):75–107.  https://doi.org/10.1093/wber/9.1.75 CrossRefGoogle Scholar
  16. Bekaert G, Harvey CR (1995) Time-varying world market integration. J Finance.  https://doi.org/10.2307/2329414 CrossRefGoogle Scholar
  17. Bekaert G, Harvey C (2002) Research in emerging markets finance: looking to the future. Emerg Mark Rev 3(4):429–448.  https://doi.org/10.2139/ssrn.795364 CrossRefGoogle Scholar
  18. Bekaert G, Harvey CR (2013) Emerging equity markets in a globalizing world. Academia 2012:1–25.  https://doi.org/10.2139/ssrn.2344817 CrossRefGoogle Scholar
  19. Bekaert G, Harvey CR, Lundblad CT (2003) Equity market liberalization in emerging markets. J Financ Res XXVI(3):275–299CrossRefGoogle Scholar
  20. Bekaert G, Erb CB, Harvey CR, Viskanta TE (1996) The behaviour of emerging market returns. In: Emerging market capital flows, Springer, Boston, pp 107–173Google Scholar
  21. Bernanke BS, Kuttner KN (2005) What explains the stock market’s reaction to federal reserve policy? J Finance 60(3):1221–1257.  https://doi.org/10.1111/j.1540-6261.2005.00760.x CrossRefGoogle Scholar
  22. Blondel VD et al (2008) Fast unfolding of communities in large networks. J Stat Mech Theory Exp 2008(10):P10008CrossRefGoogle Scholar
  23. Bostanci G, Yilmaz K (2015) How connected is the global sovereign credit risk network? Available at SSRN 2647251Google Scholar
  24. Brunetti C, Harris JH, Mankad S, Michailidis G (2015) Interconnectedness in the interbank market. Finance and economics discussion series 2015-090. Board of Governors of the Federal Reserve System, Washington.  https://doi.org/10.17016/FEDS.2015.090
  25. Buigut S, Author C (2011) International financial integration of the Indian money market. Int J Econ Finance 3(4):170–180.  https://doi.org/10.5539/ijef.v3n4p170 CrossRefGoogle Scholar
  26. Buse R, Schienle M (2019) Measuring connectedness of euro area sovereign risk. Int J Forecast 35(1):25–44CrossRefGoogle Scholar
  27. Cappiello L, Engle RF, Sheppard K (2006) Asymmetric dynamics in the correlations of global equity and bond returns. J Finance Econ 4(4):537–572Google Scholar
  28. Cenedese G, Mallucci E (2016) What moves international stock and bond markets? J Int Money Finan 60:94–113CrossRefGoogle Scholar
  29. Chambet A, Gibson R (2008) Financial integration, economic instability and trade structure in emerging markets. J Int Money Finance 27(4):654–675.  https://doi.org/10.1016/j.jimonfin.2008.02.007 CrossRefGoogle Scholar
  30. Chen J, Griffoli T, Sahay R (2014) Spillovers from United States monetary policy on emerging markets: different this time? IMF working paper. http://ideas.repec.org/p/imf/imfwpa/14-240.html
  31. Cronin D (2014) The interaction between money and asset markets: a spillover index approach. J Macroecon 39(PA):185–202.  https://doi.org/10.1016/j.jmacro.2013.09.006 CrossRefGoogle Scholar
  32. De Santis RA, Zimic S (2018) Spillovers among sovereign debt markets: identification by absolute magnitude restrictions. J Appl Econ 33:727-747.  https://doi.org/10.1002/jae.2627
  33. De Santis G, Imrohoroǧlu S (1997) Stock returns and volatility in emerging financial markets. J Int Money Finance 16(4):561–579.  https://doi.org/10.1016/S0261-5606(97)00020-X CrossRefGoogle Scholar
  34. Diebold FX, Yilmaz K (2009) Measuring financial asset return and volatility spillovers, with application to global equity markets. Econ J 119(534):158–171CrossRefGoogle Scholar
  35. Diebold FX, Yilmaz K (2012) Better to give than to receive: predictive directional measurement of volatility spillovers. Int J Forecast 28(1):57–66CrossRefGoogle Scholar
  36. Diebold FX, Yilmaz K (2015) Trans-atlantic equity volatility connectedness: US and European financial institutions, 2004–2014. J Financ Econom 14(1):81–127Google Scholar
  37. Diebold FX, Yılmaz K (2014) On the network topology of variance decompositions: measuring the connectedness of financial firms. J Econom 182(1):119–134CrossRefGoogle Scholar
  38. Ehrmann M, Fratzscher M, Rigobon R (2011) Stocks, bonds, money markets and exchange rates: measuring international financial transmission. J Appl Econom 26(6):948–974.  https://doi.org/10.1002/jae.1173 CrossRefGoogle Scholar
  39. Engle RF, BT Kelly (2009) Dynamic equicorrelation. Manuscript, New York UniversityGoogle Scholar
  40. Etesami J, Habibnia A, Kiyavash N (2017) Econometric modeling of systemic risk: going beyond pairwise comparison and allowing for nonlinearity. SRC discussion paper no 66. Systemic Risk Centre, The London School of Economics and Political Science, LondonGoogle Scholar
  41. Fallis A (2013) A decomposition of global linkages in financial markets over time. J Chem Inf Model 53(9):1689–1699.  https://doi.org/10.1017/CBO9781107415324.004 CrossRefGoogle Scholar
  42. Fleming J, Kirby C, Ostdiek B (1998) Information and volatility linkages in the stock, bond, and money markets. J Financ Econ 49(1):111–137.  https://doi.org/10.1016/S0304-405X(98)00019-1 CrossRefGoogle Scholar
  43. Forbes K, Rigobon R (2001) Measuring contagion: conceptual and empirical issues. In: International financial contagion, Springer, Boston, pp 43–66. http://doi.org/10.1007/978-1-4757-3314-3_3
  44. Georgiev G (2001) Benefits of commodity investment. J Alternat Invest 4:40–8. doi:10.3905/jai.2001.318997CrossRefGoogle Scholar
  45. Gounopoulos D, Molyneux P, Staikouras SK, Wilson JOS, Zhao G (2013) Exchange rate risk and the equity performance of financial intermediaries. Int Rev Financ Anal 29:271–282.  https://doi.org/10.1016/j.irfa.2012.04.001 CrossRefGoogle Scholar
  46. Griffin JM, Hirschey NH, Kelly PJ (2008) Why does the reaction to news announcements vary across countries? Business. http://doi.org/10.2139/ssrn.1343854
  47. Hale G, Lopez JA (2018) Monitoring banking system connectedness with big data. Federal Reserve Bank of San FranciscoGoogle Scholar
  48. Heston SL, Rouwenhorst KG (1995) Industry and country effects in international stock returns. J Portf Manag 21(3):53–58.  https://doi.org/10.3905/jpm.1995.409523 CrossRefGoogle Scholar
  49. Hiang Liow K (2012) Co-movements and correlations across asian securitized real estate and stock markets. Real Estate Econ 40(1):97–129.  https://doi.org/10.1111/j.1540-6229.2011.00314.x CrossRefGoogle Scholar
  50. In F (2007) Volatility spillovers across international swap markets: the US, Japan, and the UK. J Int Money Finance 26(3):329–341CrossRefGoogle Scholar
  51. Kal SH, Arslaner F, Arslaner N (2015) The dynamic relationship between stock, bond and foreign exchange markets. Econ Sys 39(4):592–607CrossRefGoogle Scholar
  52. Kang SH, Yoon SM (2013) Revisited return and volatility spillover effect in Korea. Korea World Econ 14(1):121–145Google Scholar
  53. King MA, Wadhwani S (1990) Transmission of volatility between stock markets. Rev Financ Stud.  https://doi.org/10.1093/rfs/3.1.5 CrossRefGoogle Scholar
  54. Klößner S, Sekkel R (2014) International spillovers of policy uncertainty. Econ Lett 124(3):508–512CrossRefGoogle Scholar
  55. Koop G, Pesaran MH, Potter SM (1996) Impulse response analysis in nonlinear multivariate models. J Economics 74(1):119–147CrossRefGoogle Scholar
  56. Kyle AS, Xiong W (2001) Contagion as a wealth effect. J Finance 56(4):1401–1440CrossRefGoogle Scholar
  57. Lane PR, Schmukler SL (2007) The international financial integration of China and India. World Bank, WasingtonCrossRefGoogle Scholar
  58. Lee H-H, Huh H-S, Park D (2013) Financial integration in East Asia: an empirical investigation. World Econ 36(4):396–418.  https://doi.org/10.1111/twec.12030 CrossRefGoogle Scholar
  59. Lessard DR (1973) International portfolio diversification: a multivariate analysis for a group of Latin American countries. J Finance 28(3):619–633CrossRefGoogle Scholar
  60. Lim K-P, Brooks RD, Kim JH (2008) Financial crisis and stock market efficiency: empirical evidence from Asian countries. Int Rev Financ Anal 17(3):571–591.  https://doi.org/10.1016/j.irfa.2007.03.001 CrossRefGoogle Scholar
  61. Malik S, Xu T (2017) Interconnectedness of global systemically-important banks and insurers. International Monetary FundGoogle Scholar
  62. Panchenko V, Wu E (2009) Time-varying market integration and stock and bond return concordance in emerging markets. J Bank Finance 33(6):1014–1021.  https://doi.org/10.1016/j.jbankfin.2008.10.016 CrossRefGoogle Scholar
  63. Pesaran HH, Shin Y (1998) Generalized impulse response analysis in linear multivariate models. Econ lett 58(1):17–29CrossRefGoogle Scholar
  64. Raj J, Dhal S (2008) Integration of India’s stock market with global and major regional markets. Bank for International Settlements Press 42:202–236. https://www.bis.org/publ/bppdf/bispap42.pdf#page=214
  65. Rigobon R, Sack B (2003) Measuring the reaction of monetary policy to the stock market. Q J Econ 118(2):639–669CrossRefGoogle Scholar
  66. Ross S (1989) Information and volatility: the no–arbitrage martingale approach to timing and resolution irrelevancy. J Finance 44:1–17CrossRefGoogle Scholar
  67. Roy RP, Roy SS (2017) Financial contagion and volatility spillover: An exploration into Indian commodity derivative market. Econ Model 67:368–380CrossRefGoogle Scholar
  68. Sahay R, Arora V, Arvanitis T, Faruqee H, Diaye PN (2014) Emerging market volatility: lessons from the taper tantrum. IMF staff discussion note (September), pp 1–29Google Scholar
  69. Segoviano M, Espinoza R (2017) Consistent measures of distress dependence. IMF working paper (forthcoming)Google Scholar
  70. Sehgal S, Gupta P, Deisting F (2014) Assessing time-varying stock market integration in EMU for normal and crisis periods. MPRA paper (64078). http://ideas.repec.org/p/pra/mprapa/64078.html
  71. Solnik BH (1974) Why not diversify internationally rather than domestically? Finance Anal J 15:48–54CrossRefGoogle Scholar
  72. Sumner DA (2009) Recent commodity price movements in historical perspective. Am J Agr Econ 91:1250–1256CrossRefGoogle Scholar
  73. Tai C (2007) Market integration and contagion: evidence from Asian emerging stock and foreign exchange markets market. Emerg Mark Rev 8(4):264–283CrossRefGoogle Scholar
  74. Underwood S (2009) The cross-market information content of stock and bond order flow. J Finance Market 12:268–289CrossRefGoogle Scholar
  75. Vychytilová J (2014) Intermarket technical research of the US Capital markets and the Czech stock market performance. Acta Universitatis Agriculturae et Silviculturae Mendelianae BrunensisGoogle Scholar
  76. Wen X, Wei Y, Huang D (2012) Measuring contagion between energy market and stock market during financial crisis: a copula approach. Energy Econ 34(5):1435–1446.  https://doi.org/10.1016/j.eneco.2012.06.021 CrossRefGoogle Scholar
  77. Wolf HC (2000) Intranational home bias in trade. Review Econ Stat 82(4):555–563CrossRefGoogle Scholar
  78. Yang J, Hsiao C, Qi L, Wang Z (2006) The emerging market crisis and stock market linkages: further evidence. J Appl Econ 21:727–744CrossRefGoogle Scholar

Copyright information

© Indian Institute of Management Calcutta 2018

Authors and Affiliations

  1. 1.Department of Financial StudiesUniversity of DelhiNew DelhiIndia

Personalised recommendations