Modelling Financial Contagion in the South African Equity Markets Following the Subprime Crisis
Abstract
This paper used wavelet analysis and Dynamic Conditional Correlations model derived from the Multivariate Autoregressive Conditional Heteroskedasticity (MGARCH-DCC) to investigate the possible presence of financial contagion in the South African equity market in the wake of the subprime crisis that occurred in the United States. The study uses Dornbusch, Park and Claessens’s (2000) broader definition which asserts that financial contagion only takes place if cross-correlation between two markets is relatively low during the tranquil period, and that a crisis in one market results in a substantial increase cross-market correlation. Using wavelet analysis, the study found high levels of correlation during the subprime financial crisis in both smaller and longer timescales. In the former, high correlation was identified as financial contagion, whereas in the latter it was found to indicate co-movement due to financial fundamentals. The high correlation was identified for small scales 3, 4 and 5 that range from a week to one month indicates the presence of contagion. The study also used the MGARCH-DCC model to compare the cross-market correlation between the SA and the US markets, during a ‘pre-crisis’ and ‘crisis’ period. The study used data for the period between January 2005 and December 2007 for the ‘pre-crisis’ period and that for the period from January 2008 to December 2014 for the ‘crisis’ period. The results indicate cross-market linkages only during the crisis period; hence, it was concluded that cross-market correlation during the period of financial turmoil in the US was the result of financial contagion.
Downloads
References
Boyer, R., Dehove, M. & Plihon, D. (2004). Les crises financières. Paris: La Documentation Francaise.
Chinzara, Z. & Aziakpon, M. J. (2009). Dynamic Returns Linkages and Volatility Transmission between South African and World Major Stock Markets. Studies in Economics and Econometrics, 33(3), 69-94.
Collins, D. & Biekpe, N. (2003). Contagion and interdependence in African stock markets. South African Journal of Economics, 7(1), 181-194.
Dajcman, S. (2013). Interdependence between some major European stock markets—a wavelet lead/lag analysis. Prague economic papers, (1), 28-49.
Dornbusch, R., Park, c. y. & Claessens, S. (2000). Contagion: Understanding How It Spreads. The World Bank Research Observer, 15(2), 177-197.
Engle, R. (2002). Dynamic conditional correlation: A simple class of multivariate generalized autoregressive conditional heteroskedasticity models. Journal of Business & Economic Statistics, 20(3), 339-350.
Forbes, K. J. & Rigobon, R. (2002). No contagion, only interdependence: measuring stock market co-movements. The Journal of Finance, 57(5), 2223-2261.
Gençay, R., Selçuk, F. & Whitche, B. (2003). Systematic risk and timescales. Quantitative Finance, 3(2), 108-116.
Hashim, K. K. & Masih, M. (2015). Stock market volatility and exchange rates: MGARCH-DCC and wavelet approaches.". Retrieved 03 18, 2018, from https://mpra.ub.uni-muenchen.de/65234/1/MPRA_paper_65234.pdf Hemche, O., Jawadi, F., Maliki, S. B. & Cheffou, A. I. (2016). On the study of contagion in the context of the subprime crisis: A dynamic conditional correlation–multivariate GARCH approach. Economic Modelling, 52, 292-299.
Heymans, A. & Da Camara, R. (2013). Measuring spill-over effects of foreign markets on the JSE before, during and after international financial crises. South African Journal of Economic and Management Sciences, 16(4), 418-434.
Kaminsky, L. G. & Reinhart , M. C. (2000). On crises, contagion, and confusion. Journal of International Economics, 51(1), 145-168.
Kaminsky, G. L., Reinhart, C. M. & Vegh, C. A. (2003). The unholy trinity of financial contagion. Journal of economic perspectives, 17(4), 51-74.
Kenourgios, D. & Dimitriou, D. (2015). Contagion of the Global Financial Crisis and the real economy: A regional analysis. Economic Modelling, 44, 283-293.
Lam, E. (2018). Dollar Index replaces VIX as new market gauge of fear. Retrieved March 03, 2018 from https://www.bloomberg.com/news/articles/2018-05-17/dollar-index-replaces-vixnewmarket-gauge-of-fear-chart
Lam, M. C. H. (2002). Herd behaviour and interest rate defence. Journal of Policy Modeling, 24(2), 181-193.
Office of the United States trade representative (2018). Retrieved June 11, 2018
Percival, D. B. & Walde, A. T. (2006). Wavelet methods for time series analysis (Vol. 4). Cambridge university press.
Percival, D. P. (1995). On estimation of the wavelet variance. Biometrika, 83(2), 619-631.
Ranta, M. (2010). Wavelet multiresolution analysis of financial time series. Helsinki: Universitas Wasaensis.
Saiti, B. (2016). Testing the Contagion between Conventional and shari'ah-Compliant Stock Indices: Evidence from Wavelet Analysis. Emerging market Finance and trade, 52(8).
Valdés, R. (2000). Emerging markets contagion: evidence and theory. Retrieved April 6, 2015, from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=69093
Copyright (c) 2019 Olivier Niyitegeka
This work is licensed under a Creative Commons Attribution 4.0 International License.
Author (s) should affirm that the material has not been published previously. It has not been submitted and it is not under consideration by any other journal. At the same time author (s) need to execute a publication permission agreement to assume the responsibility of the submitted content and any omissions and errors therein. After submission of a revised paper in the light of suggestions of the reviewers, editorial team edits and formats manuscripts to bring uniformity and standardization in published material.
This work will be licensed under Creative Commons Attribution 4.0 International (CC BY 4.0) and under condition of the license, users are free to read, copy, remix, transform, redistribute, download, print, search or link to the full texts of articles and even build upon their work as long as they credit the author for the original work. Moreover, as per journal policy author (s) hold and retain copyrights without any restrictions.
