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Modelling Financial Markets Comovements during Crises: A Dynamic Multi-Factor Approach

Dynamic Factor Models

ISBN: 978-1-78560-353-2, eISBN: 978-1-78560-352-5

Publication date: 6 January 2016

Abstract

We propose a novel dynamic factor model to characterise comovements between returns on securities from different asset classes from different countries. We apply a global-class-country latent factor model and allow time-varying loadings. We are able to separate contagion (asset exposure driven) and excess interdependence (factor volatility driven). Using data from 1999 to 2012, we find evidence of contagion from the US stock market during the 2007–2009 financial crisis, and of excess interdependence during the European debt crisis from May 2010 onwards. Neither contagion nor excess interdependence is found when the average measure of model implied comovements is used.

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Acknowledgements

Acknowledgements

We wish to thank participants in the Finance Research Workshops at Cass Business School (London, 8 October 2012), in particular A. Beber and K. Phylaktis, in the Fifth Italian Congress of Econometrics and Empirical Economics (Genova, 16–18 January 2013), in the Third Carlo Giannini PhD Workshop in Econometrics (Bergamo, 15 March 2013), in particular, M. Bertocchi, L. Khalaf and E. Rossi, in the CREATES Seminar (Aarhus, 4 April 2013), in particular, D. Kristensen, N. Haldrup, A. Lunde, and T. Terasvirta, in the Seminari di Dipartimento Banca e Finanza of Università Cattolica del Sacro Cuore (Milan, 13 December 2013), in particular, C. Bellavite Pellegrini, in the 14th OxMetrics User Conference at The George Washington University (Washington, 20–21 March 2014), in the 16th Advances in Econometrics Conference on Dynamic Factor Models at CREATES (Aarhus, 14–15 November 2014), in paricular, J. Breitung, M. Hallin and M. Marcellino, for useful discussions and valuable comments. Special thanks to the Editors, Eric Hillebrand and Siem Jan Koopman, and two anonymous referee for very helpful comments and suggestions that greatly helped to improve this paper. Riccardo Borghi has provided very insightful comments on a previous version of this paper. The usual disclaimer applies. Riccardo Pianeti acknowledges financial support from the Centre for Econometric Analisis at Cass and the EAMOR Doctoral Programme at Bergamo University.

Citation

Belvisi, M., Pianeti, R. and Urga, G. (2016), "Modelling Financial Markets Comovements during Crises: A Dynamic Multi-Factor Approach", Dynamic Factor Models (Advances in Econometrics, Vol. 35), Emerald Group Publishing Limited, Leeds, pp. 317-360. https://doi.org/10.1108/S0731-905320150000035008

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Emerald Group Publishing Limited

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