Volatility and asymmetric dependence in Central and East European stock markets
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Volatility and asymmetric dependence in Central and East European stock markets Nathan Lael Joseph1 · Thi Thuy Anh Vo2 · Asma Mobarek3 · Sabur Mollah4
© The Author(s) 2020
Abstract We study the effects of contagion around the global financial crisis (GFC) and the Eurozone crisis periods using German and UK returns, each paired with returns from Central and East European (CEE) stock markets that recently joined the European Union (EU). Using bivariate vector error-correction models (VECMs) estimated in GARCH(1,1), we find strong support for long-run equilibrium conditions. This finding suggests that tests of tail dependence using differenced VARs may be mis-specified when long-run equilibrium conditions apply. Past news has more persistence on current volatility in CEE markets than in the developed markets. Past volatility has more persistence in the developed markets compared to the CEE markets. The T-V symmetrized Joe–Clayton (T-V SJC) copula outperforms all other copulas in goodness-of-fit, including, the T-V Gaussian and Student t copulas. This result is supported by a differenced VAR-GARCH (1,1). For CEE and developed market returns, no more than half of our market pairs exhibit significant increases in lower tail dependence, under the T-V SJC copula. Given the number of paired comparisons, the evidence on joint extreme dependence is weak. As such, CEE stock markets experienced little contagion effects during the GFC and Eurozone crisis periods, contrary to prior results. We find that the legal environment negatively impacts financial development, perhaps causing CEE and the EU markets to be isolated. Keywords Cross-country contagion · Global financial crisis · Eurozone crisis · GARCH · Vector error-correction models · Time-varying copula functions JEL Classification G1 · G11 · G14 · G15
* Nathan Lael Joseph [email protected] Thi Thuy Anh Vo [email protected] 1
Aston Business School, Aston University, Birmingham, UK
2
University of Economics, University of Danang, Danang, Vietnam
3
Cardiff Business School, Cardiff University, Cardiff, UK
4
University of Sheffield, Western Bank, Sheffield S10 2TN, UK
13
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N. L. Joseph et al.
1 Introduction Over the past two decades or so, academic researchers, practitioners and regulators have developed renewed interest in low-probability events associated with the dependence structure of asset returns. Both the global financial crisis (GFC) of 2007‒2009 and the Eurozone crisis of 2010‒2018 demonstrate the economic problems associated with financial linkages and contagion effects.1 One interesting area relates to the dependence structure of pairs of equity market returns around economic shocks or crisis events. Indeed, Erb et al. (1994) and Longin and Solnik (2001) report that pairs of stock market returns exhibit stronger correlations during market declines compared to market upturns. A more complete approach to test for extreme dependence is to decompose the multivariate joint distribution of stock returns into their marginal d
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