A revisit to stock market contagion and portfolio hedging strategies

Abstract

Purpose This paper aims to attempt to re-capture the stock market contagion effect from the US to the BRIC equity markets during the recent global financial crisis in a multivariate framework. Apart from this, the study also identifies optimal portfolio hedging strategies to minimize the underlying portfolio risk during the period undertaken for the purpose of study. Design/methodology/approach To account for the dynamic interactions, the study uses vector autoregression (p) dynamic conditional correlation (DCC)-asymmetric generalized autoregressive conditional heteroskedastic (1,1) model in a multivariate framework, coupled with a monthly heat map relating to the co-movement between the US and the BRIC equity markets during the period 2007-2009. Finally, by following the studies, Hammoudeh et al. (2010) and Syriopoulos et al. (2015), the time-varying optimal portfolio hedge ratios and weights are computed. Findings The results report a contagion impact of the US subprime crisis (following the collapse of the Lehman Brothers) on the Indian and Russian stock markets only. On the other hand, a higher degree of interdependence between the US and Brazilian market has been observed. The US and Chinese equity markets indicate a relatively lower level of interdependence among themselves. The optimal hedge ratios are found to be most effective for a portfolio comprising the US and Chinese stocks even during the crisis period. A US investor should invest approximately 30 cents in the Indian market and rest of the 70 cents in the US market in a US$1 portfolio to minimize the portfolio risk without lowering the expected returns. During the crisis period (2007-2009), the optimal portfolio weights indicate a higher weightage to the BRIC stocks. Practical implications The results support the construction of optimal US–BRIC stock portfolios and provide an insight to the investors and policy makers both domestic as well as international, with regard to the contagion impact and interdependence, especially during a crisis period. Originality/value The study uses a DCC model in a multivariate framework instead of bivariate, wherein all the markets are factored into a single interaction framework across a very long period (2004-2014). Second, a heat map of monthly correlation combinations has been created for the period 2007-2009, to comprehend the contagion impact or interdependence among the markets. Finally, the study ascertains time-varying optimal hedge ratios and portfolio weights for a two asset portfolio, from a US investor viewpoint, making the study first of its kind in all the perspectives.

A revisit to how linkages fuel dependent economic policy initiatives

“…On an expected note, we could not find any significant evidence of causality relationships between the US and Chinese financial systems. Furthermore, co-movement between the US–Indian and US–Russian financial stress indices reached to its respective highest levels during the sub-prime crisis period, further confirmed by Markov switching model results [consistent with Singh and Singh (2017b)]. Possibly, it could be due to increasing real and financial linkages between the US, Russian and Indian economic systems.…”

“…Numerous studies have tried to capture the linkages between the international financial markets comprising equity, debt and foreign exchange markets. For instance, Ismail and Rahman (2009), Diebold and Yilmaz (2009), Gangadharan and Yoonus (2012), Singh and Singh (2017b)[1] captured the linkages existing between the international equity markets. There are some studies that have also tried to account for the linkages existing between the international bond markets such as Yang (2005).…”

A Wavelet Perspective of Crisis Contagion between Advanced Economies and the BRIC Markets

“…In more recent studies, Singh and Singh (2017) published a study of stock markets' contagion effects from the U.S. to BRIC stock markets using a vector autoregression (p) dynamic conditional correlation (DCC)-asymmetric generalized autoregressive conditional heteroskedastic (1,1) model. The study utilized heat mapping methodology to trace the co-movement between the U.S. and the BRIC equity markets during the period 2007-2009.…”