Systemic Risks Spillovers and Interdependence among Stock Markets: International Evidence with Covar‐Copulas

• Author: Gideon Boako,Paul Alagidede
• Date: 01 March 2018
• DOI: http://doi.org/10.1111/saje.12182
• Published date: 01 March 2018

SYSTEMIC RISKS SPILLOVERS AND INTERDEPENDENCE

AMONG STOCK MARKETS: INTERNATIONAL EVIDENCE

WITH COVAR-COPULAS

GIDEON BOAKO*

,†,§

AND PAUL ALAGIDEDE

‡,§

Abstract

Empirical studies have provided ample evidence on the potential benefits of international diversi-

fication with portfolios that consist of both domestic and foreign assets. This coupled with sud-

den and periodic crashes in global and developed equity markets have stimulated the interest of

investors to diversify across markets that have the potential to provide decorrelation with global

markets during turbulent periods. At the same time, international diversification may intensify

cross-border listing of stocks with its antecedent implication of shocks transmission. The above

have engendered renewed interest among researchers to explore the dependence levels and spill-

over effects of shocks among emerging and developed equity markets. This paper examines tail

dependence structure and (extreme) systemic risks spillover effects among international equity

markets using advanced econometric techniques that underpin the modelling of asset returns. We

find evidence of low positive significant dependencies between all African markets and their

developed counterparts, except for Egypt. Although no evidence of spillover effects to the markets

in Africa was found, both unidirectional and bi-directional causality between some African and

developed equity markets is found, albeit with differences. We are unable to ascribe the dynamics

in the causality structure to level of market integration. It is inferred that the degree of individual

local markets interdependence with developed counterparts may reflect the relative size, liquidity

and degree of foreign investors’ participation.

JEL Classification: C2, F35, G10, G15

Keywords: CoVaR-copula, Africa, equity markets, systemic risk, spillover effects

1. INTRODUCTION

Recent development characteristics across stock markets of many emerging economies

point to increases in liquidity levels, higher degrees of regional and international integra-

tion, improved foreign investor participation and enhanced governance structures to

facilitate trading and transactions. While such developments help ease cross-border flow

of portfolio equity to in turn inject more liquidity into national economies for economic

growth, among others, the risk of transmission of shocks across markets cannot be over-

looked. In fact, it is observed that the fear of becoming vulnerable to contagion effects

* Corresponding author: Director of Training, African Finance & Economics Consult

(AFEC), Johannesburg, South Africa. Tel: 1233242137523. E-mail: gboako@gmail.com

†

Department of Accounting and Finance, Kwame Nkrumah University of Science and

Technology

‡

Wits Business School, 2 ST David’s Place, University of the Witwatersrand Graduate

School of Business

§

African Finance and Economics Consult (AFEC)

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C2017 Economic Society of South Africa. doi: 10.1111/saje.12182

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of Economics

prevent several governments from institutionalising policies for domestic market’s inte-

gration (Coudert et al., 2013), enhancing international investors participation, and so

on. Meanwhile, the connectedness between developed and emerging economies remains

a critical factor to the development and modernisation of the global economy.

Despite improvements in developments across emerging markets and the continued

adoption of certain market innovations such as liberalizations across developing countries,

the discussion on whether or not emerging markets have reached development pinnacles

commensurate to the levels of developed markets for all to be treated as a unit bucket of

assets appears far from settled. While Saunders and Walter (2002) suggest that the contin-

ued adoption of certain market innovations such as liberalizations across developing coun-

tries defeats the argument to separate emerging and developed equity market classes,

Bekaert and Harvey (2014) have observe that even though globalisation and market

libearlisations appear to increase over time, there is some wisdom in considering emerging

equity markets as a separate asset class – see also Boako and Alagidede (2016a,b).

Recent global economic and financial developments have re-ignited the need to re-

assess emerging economies independence and self-sufficiency levels (Claessens et al.,

2010), in the broader context of the global economy. In this context, Africa deserves par-

ticular attention due to its recent strengthening of economic links with developed coun-

tries (see Sugimoto et al., 2014). Further, with open market policies to international

investors and increased efforts at overcoming barriers to international trade, investments

in African economies have increasingly become attractive to foreign investors. This makes

studies on the spillover of global risks to African economies an interesting arena for both

local and international investors.

This paper examines the price effects of developed stock market risk in equity investments

in Africa, with particular emphasis on dependence, interdependence and (extreme) downside

spillovers. Further, the study sheds light on African stock markets potential to act as viable

investment alternatives for international portfolio investors, both in tranquil and turbulent

times. The following questions are investigated: Do stock markets have a discernible influ-

ence on each other? Are there spillover effects from developed equity markets to African

stocks during (extreme) downside market conditions? Do developed equity markets price

risks contain information that may inform the decisions of international equity portfolio

investors in Africa? Outcomes from the paper highlight whether or not African stock markets

can provide the kind of decorrelation that global markets and other traditional assets like

commodities are unable to offer during crisis. Such outcomes are important because the

absolute risk of developing/emerging markets is generally irrelevant from the investor per-

spective (Bekaert and Harvey, 2014), and that, the dependence between developed and devel-

oping/emerging markets will be an ultimate driver of the ultimate risk borne (Bekaert and

Harvey, 2014) by international investors seeking diversification via uncorrelated markets.

The paper makes the following contributions to the literature. Although several stud-

ies have examined the dependence structure and spillover effects across international

equity markets, the empirical literature on tail-spillover effects with particular attention

to the quantification of and testing for the impact of downside movements in developed

stock markets on the (extreme) downside risks in emerging stock markets are very scanty.

The dearth of related studies on Africa is very harrowing. The pioneering paper by

Mensah and Alagidede (2017) and the recent one by Boako and Alagidede (2017) on

Africa are however notable. By examining how Africa’s stock markets are related to

advanced markets using CoVaR-copulas, Mensah and Alagidede (2017) suggest that, but

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