Volatility Spillover from the Fear Index to Developed and Emerging Markets

ABSTRACT

This article examines cross-market volatility linkages among the fear index (VIX), the developed-market index (VXEFA), and the emerging-market index (VXEEM). Analysis on the first moments of volatilities reveals that the fear index has a leading role and has information content for VXEFA and VXEEM. A shock to the fear index spillovers to VXEFA and VXEEM and contributes 57.07% and 63.77% to their shocks, respectively. Further analysis on the second moments of volatilities confirms that the volatility indices are highly dynamically correlated while the fear index drives the correlation dynamics with the VXEEM. Correlations increase in turbulent periods and decrease in tranquil periods.

KEY WORDS:

• emerging markets
• implied volatility spillovers
• VIX
• VXEEM
• VXEFA

Notes

^1. The VIX index is widely dubbed as the investors “fear index” (see Whaley 2000).

^2. Particularly institutional investors who actively seek to invest in high yield emerging-market equities and diversify their portfolios across borders to receive the benefits of diversification (i.e., reducing risks).

^3. www.cboe.com/vix; www.cboe.com/vxefa; www.cboe.com/vxeem.