Financial contagion in emerging markets evidence from BRICS countries
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Date
2019
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University of Zululand
Abstract
The present study examines the pure form of contagions in the BRICS countries, namely Brazil, Russia, India, China, and South Africa. The pure form of contagion refers to the propagations of shocks due to reasons that are not related macroeconomic fundamentals, and are solely the result of irrational phenomena, such as panics, herd behaviour, loss of confidence and risk aversion. The choice of BRICS was motivated by the fact that these emerging countries have stronger partnerships through the BRICS association. Additionally, these countries come from various continents across the world. This allowed the study to have a worldwide overview of how contagions are transmitted, not only in one region but across regions.
The main objective of this study was to examine co-movement and volatility spillover in BRICS countries from ‘source’ markets of the U.S. and Eurozone region. Specifically, the study sought to accomplish the following objectives: (i) To examine the salient characteristics of equity markets in BRICS countries, (ii) To investigate the nature of stock market returns’ volatility for BRICS countries during periods of financial turmoil, (iii)To examine the presence of time-varying conditional correlations in BRICS’ equity market returns, in the wake of the financial crises that took place in the U.S. and Eurozone countries, and (iv) To investigate the presence of time-frequency correlations in BRICS stock markets, following the financial crises that took place in the U.S. and Eurozone countries.
The following four econometric models were formulated and utilised by the study: (i) GARCH (1, 1) and its extensions; (ii) the diagonal VECH GARCH (1, 1); (iii) the Dynamic Conditional Correlation GARCH; (iv) and Wavelet analysis. The study found that stock markets within BRICS countries are heterogeneous as they differ in their structural characteristics, economic policies, and geopolitical importance. The Chinese and Russian markets are still in the maturing process as they only reopened recently after decades of communist regimes that prohibited security markets. The Brazilian, Russian and South African stock markets are dominated by natural resource-based stocks, and they are well known commodity exporters. Among the BRICS stock markets, China’s market has experienced the most rapid growth in the past 20 years. The results of Univariate GARCH modelling revealed the persistence of volatility in the BRICS returns, with China (SSE) having the highest volatility persistence, followed by India (SENSEX) and Russia (RTSI). Using GARCH (1,1) variants, the study also found evidence of leverage effect in all BRICS stock markets except China.
Bivariate GARCH models were used to examine the dynamic cross-correlation between individual BRICS stock markets as target markets and the U.S. and Eurozone as ground zero (source) markets. The study showed that the cross-conditional volatility coefficient is high in magnitude during periods of financial upheaval compared to a tranquil period, hence the conclusion that there was financial contagion in BRICS stock markets (with the exception of the Chinese stock market) during the U.S. sub-prime and the Eurozone sovereign debt crises. The wavelet cross-correlations analysis showed evidence of positive cross-correlation between the U.S. and individual BRICS stock markets, and the cross-correlation was identified in both short and coarse scales, with the U.S. leading BRICS countries. The cross-correlation between the U.S. and Chinese equity market could not be established.
Regarding the Eurozone sovereign debt crisis, the wavelet cross-correlation analysis shows evidence of co-movement and volatility spillover in the short scales, with the DAX leading the BRICS market indices. Evidence of financial contagion emanating from Eurozone stock markets could only be identified in the South African and Russian stock markets. For the Brazilian, Indian, and Chinese markets, no correlation was identified in the short scale period, hence the conclusion that no financial contagion took place in these three stock markets following the Eurozone sovereign debt crisis. The study recommends that since volatility spillover between individual BRICS equity markets and the U.S. market is unidirectional policymakers, investors and regulatory authorities should focus more on monitoring the volatility of the U.S. equity market, as efforts by authorities in BRICS countries to stabilise BRICS stock markets is futile as shocks are exogenous.
The current study also recommends that regulatory authorities should come up with initiatives that enable investors to reduce significant risk exposure by formulating sound risk management policies and macroprudential regulations. Given the fact that the current study could not identify financial contagion in Brazilian, Chinese and Indian stock markets emanating from Eurozone countries, the study recommends that policymakers policy makers need to pay due attention to idiosyncratic shock channels in responding to volatility spillover.
Description
A thesis submitted in fulfillment of the academic requirements for the degree of Doctor of Commerec in the Department of Economics in the Faculty of Commerce, Administration and Law, University of Zululand, 2020.
Keywords
BRICS, Macroeconomic, Financial contagion, Emerging markets