Modelling spillover effects between the UK and the US stock markets over the period 1935–2020

ABSTRACT

This study investigates the spillovers of shocks and volatilities between the UK and the US stock markets over the period 1935–2020. The empirical analysis is carried out for the full sample and four subsample periods by applying the asymmetric GARCH-BEKK model. Based on the empirical results, the evidence indicates that financial market linkages between the two markets have become stronger since the commencement of the European Monetary Union (EMU), which suggests that stronger financial market interactions and interdependence could increase the vulnerabilities of domestic markets to any global shocks and reduce the potential benefits of portfolio diversification.

KEYWORD:

• shock and volatility spillovers
• multivariate GARCH-BEKK
• international monetary systems

JEL CLASSIFICATION:

• C12
• E44
• F36

Notes

1 Using ‘common trading window’ approach to solve nonsynchronous trading effect – data are collected for the same dates across the stock markets, when any series has a missing value due to no trading then the previous data are brought forward (see Aladesanmi, Casalin, & Hugh, 2019).

2 The diagonal elements in matrix A capture the own ARCH effect, the diagonal elements in matrix B capture the own GARCH effect and the diagonal elements in matrix D capture the own asymmetric effect. The parameters of matrix D capture the magnitude of asymmetry of volatility effect such that the term ${\eta }_{t-1}$ takes the value 1 for negative shocks and 0 otherwise (that is, ${\eta }_{t-1}$= 1 when ${\epsilon }_{t-1}$< 0 and ${\eta }_{t-1}$= 0 when ${\epsilon }_{t-1}$ ≥ 0).

3 Following Li and Giles (2015), a VAR(2) model is adequate for the mean equation for the sample periods based on the optimal lag selection criteria.

4 The persistence of the whole system is captured by the eigenvalues of the system. The closer the eigenvalues to unity, the higher is the persistence of shocks.

5 The LR statistic tests for the null (H₀: ${\alpha }_{11}$=${\alpha }_{12}$ = ${\alpha }_{21}$= ${\alpha }_{22}$= ${\text{β}}_{11}$= ${\text{β}}_{12}$= ${\text{β}}_{21}$=${\text{β}}_{22}$ = 0).