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Abstract

This study measures the extent of crosscountry financial shock spillover by utilizing Diebold and Yilmaz (2009); Diebold and Yilmaz (2012) method and using the impulse response function of the VAR model, it explores the important channel through which financial shocks transmit among the US, Japan, Germany, China, India, and Russia. The result shows that total financial shock spillover is 43.60%, indicating that slightly more than two-fifths of the total variance of the forecast errors for six countries under consideration is explained by their shock spillover across countries. The finding is observed to be robust. Using the impulse response of the VAR model, we examined the relative importance of channels viz. financial, exchange rate, and trade. We observed that 46% of external financial shocks transmit to US through the financial channel, while it is predominantly the trade channel through which shocks transmit to Japan (43%), Germany (43%), and China (76%). India receives major shocks (74%) through exchange rate. Finally, trade and financial channels are important for Russia through which 76% of shocks come from external financial markets. The spillover is observed to be high which could be because of the increasing deregulation of financial markets including capital mobility in 21 st century. Contribution/ Originality: This study contributes in four ways: (i) it considers both advanced and emerging economies, (ii) captures financial shocks through composite interest rate index (IRI), (iii) employs spillover method developed by Diebold and Yilmaz (2009); Diebold and Yilmaz (2012) and (iv) examines the contribution of channels which previous literature did not address. 1. INTRODUCTION The crosscountry financial shock spillover remains alive in the history of global economy. For instance, the Asian Financial Crisis (1997-98) and the Global Financial Crisis (2007-09) 1 had the genesis in specific regions and 1 Asian Financial Crisis (1997-98) alternatively called as Asian Contagion defined as a sequence of currency devaluation and other follow up of economic events that stared in 1997 and impacted many countries. Global Financial Crisis (2007-09) began in 2007 from subprime mortgage market in the USA and took the turn of a great depression of 1930's. It advanced into fullblown global banking crisis with the collapse of the Lehman Brother's Investment Bank in 2008.