Does Linkage Fuel the Fire? The Transmission of Financial Stress across the Markets

Chau, F.; Deesomsak, R.

Abstract

This paper develops an indicator of financial stress transmission, called Financial Stress Spillover Index (FSSI), to monitor the condition of financial system and to identify periods of excessive spillover that may lead to financial instability. Specifically, using the “spillover index” approach of Diebold and Yilmaz (2012), we modify and extend the financial stress indices proposed by Oet et al., 2011 to track both total and directional stress spillovers across the U.S. equity, debt, banking, and foreign exchange markets. Unlike other previous studies, the important linkages among these four major financial sectors in an interconnected world are directly taken into account by considering the average and time-varying connectedness of each individual market. The evidence suggests that there are important stress episodes and fluctuations across markets; the total cross-market stress spillovers were rather limited until the onsets of financial crises. As the crises intensified, so too did the financial stress spillovers; with significant stress carrying over from debt and equity markets to the others. In addition, our results indicate that FSSI has a significant predictive power for the economic activity and provides useful information for dating financial crisis.

Citation

Chau, F., & Deesomsak, R. (2014). Does Linkage Fuel the Fire? The Transmission of Financial Stress across the Markets. International Review of Financial Analysis, 36, 57-70. https://doi.org/10.1016/j.irfa.2014.02.005

• Journal Article Type: Article
• Online Publication Date: Feb 20, 2014
• Publication Date: 2014-12
• Deposit Date: Feb 11, 2014
• Publicly Available Date: Aug 20, 2015
• Journal: International Review of Financial Analysis
• Print ISSN: 1057-5219
• Electronic ISSN: 1873-8079
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 36
• Pages: 57-70
• DOI: https://doi.org/10.1016/j.irfa.2014.02.005
• Keywords: Banking, Financial crises, Financial stress transmission, Spillover index.
• Public URL: https://durham-repository.worktribe.com/output/1438342