We updated the connectedness measures for stock, sovereign
bond, and FX markets using data up to the end of August. The results provide us with lots of material
to write about. In this blog I analyze the behavior of the
volatility connectedness in global stock markets. Bond and FX markets will follow next.
Before I start with the stock market volatility
connectedness, I want to highlight one development that affected volatility
connectedness in all three markets, albeit at varying degrees. Having a quick
look at dynamic connectedness graphs show that there is an upward move in the
volatility connectedness of stock, sovereign bond and FX markets immediately
around mid-October 2014. Actually, all three markets were affected by the
volatility jump in the U.S. bond market on October 15, 2014. Market observers linked the jump in daily
bond market volatility to electronic trading and named the developments on
October 15, 214 as the “flash crash”.
Following the “flash crash” volatility connectedness across
stock markets increased gradually to reach 65% in mid-February. After that peak the volatility connectedness
came down steadily. The stand-off between Greece and the EU in late June about
the implementation of economic policies dictated by the IMF, the European
Commission and the ECB led to a quick increase in the stock market volatility
connectedness from 56.7% on June 24 to 61.1% on July 10. Once the Greek
government decided to implement the dictated policies the volatility
connectedness across stock markets declined gradually to 53.8 on August 20.
Chinese stock market declined by around 40% from its peak in
June to mid-August. This downward trend in the volatility connectedness index was
realized despite the troubles in the Chinese stock market. However, there was a
big jump in the index on August 24. From 55.4% on Friday August 21, the total
volatility connectedness index jumped to 64.4% on Monday, August 24. That is
the day when the Chinese market dropped 8.3%.
During the day all eyes focused on the Chinese market. Many followed the jump in the VIX index from
19 to 41, the highest level since the European debt crisis in 2011. Yet, a look
at the directional volatility network as of August 31 reveals that the European
countries were the most important generators of volatility connectedness.
Actually, European stock markets were generating connectedness towards each
other more than the stock markets in other parts of the world. One can talk
about the presence of a European cluster where the country nodes located towards
the center of the cluster all have red color, while the ones on the periphery have
orange and brown colors.
Leaving the European countries aside, U.S. stock market
generated the highest connectedness to others. It generated most of the
connectedness toward Latin American and European markets, Canada, India and
Indonesia. China, on the other hand, was a net recipient of volatility
connectedness from others. China’s
pairwise connectedness with Hong Kong was the highest. It was a net recipient
of connectedness from all European countries.
