An Empirical Study on Volatility Spillovers Evidence from India

Abstract

Purpose: With the increasing openness and technological advancement in the Indian economy, the financial market has become more connected with the international markets, especially with the developed countries. Furthermore, post the global crisis of 2007 08, foreign institutional investors flocked to the Indian market for its higher return potential. The enormous foreign capital inflow also increases the risk potential of the Indian financial market. This paper aims to examine volatility connectedness among a few developed nations(G7 countries) and India to explore the volatility transmission across these stock markets throughout the Indian financial cycle (IFC). newlineMethodology: The study has employed two different methodologies to evaluate the volatility spillover mechanism among these eight countries. Firstly, a bi-variate DCC GARCH model was applied to examine the volatility transmission from all G7 countries tothe Indian financial market. The study also compared the conditional correlations between the two phases of the financial cycle to understand the evolution of conditional correlations between countries. Secondly, the study aims to identify the country which may be responsible for major volatility spillover and potential vulnerability for the Indian financial market. To map the source country, we have applied the Diebold-Yilmaz connectedness index (Diebold and Yilmaz, 2009; 2012)to yield the spillover index and connectedness. Later, a pairwise connectedness was formulated to evaluate spillover towards the Indian market. newlineFindings: The empirical research shows strong interactions between India and G7 nations throughout the IFC. The upcycle is characterised by only long-term volatility spillover between all the G7 nations and the Indian market, but no short-term spillover is being noticed except in the case of Japan and India. In the downcycle, except for the US market and Japan, the rest of the 5 countries exhibit short-term volatility spillover into the Indian market. Utilising the testing equality of means and variance of conditional correlation between G7 nations and India in two phases, we found that only Japan exhibits a change in the mean of conditional correlation. On the other hand, except Canada, all G7 nations displayed a significant change in the variance of conditional correlations with the Indian market. Furthermore, with the DYCI framework, we produce evidence of change in the network diagrams in two phases of IFC. In full sample estimations, we found that since 2013, Italy was the major source of volatility spillover for the Indian market. newlineOriginality: This research contributes to the mapping of volatility spillover between G7 newlinenations and India at various periods of the financial cycle. This study is more pertinent to risk managers and portfolio managers because the conditional correlation between countries would aid portfolio managers in developing hedging methods and reducing risk in the domestic portfolio. newline newline