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

Chau, F.; Deesomsak, R.

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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 Mar 29, 2024
Journal International Review of Financial Analysis
Print ISSN 1057-5219
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

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Copyright Statement
NOTICE: this is the author’s version of a work that was accepted for publication in International review of financial analysis. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in International review of financial analysis, 36, 2014, 10.1016/j.irfa.2014.02.005




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