Spillover Effects of the Recent Financial Crisis on Selected Emerging Markets vs. Developed EU Markets

This thesis examines the existence of interdependencies and dynamic correlation behaviour among the selected emerging and developed stock markets during tranquil and turbulent periods to provide an empirical analysis and comparison of the spillover effects of the recent global financial crisis (GFC) and the European sovereign debt crisis (ESDC) using two different data sets. In the first part, the spillover effects on fast growing emerging economies and the developed markets that resulted from the global financial crisis is investigated. The emerging economies are represented by BRIC-Turkey plus three CEE markets (an acronym used to describe Brazil, Russia, India, China, Turkey and three emerging central European countries, namely the Czech Republic, Hungary, and Poland). The developed markets are represented by the UK, Germany, and France – hereafter the EU3. To measure the impact of the global financial crisis on these countries, the US stock price index is used. In addition to this, to precisely account for indirect transmissions and the regional factor in emerging economies, the EUROSTOXX50 (EU) index, which includes the 50 “blue chip” companies operating in twelve advanced European countries, is included as a proxy for Eurozone. Since the operating hours among the above markets are different, a weekly stock market index from Wednesday to Wednesday is used in order to minimise the cross-country differences and the end-of-week effect for each country for the period of 3 January 2001 to 13 November 2013. All of the stock prices are obtained from Thomson Reuters Datastream Professional in dollar terms (as a common currency) to account for the local inflation rate. A multivariate GARCH framework is used in studying the correlation spillovers between each country with the US and EU indexes and to capture the time-variability of the conditional correlations, a dynamic structure is included by using the DCC model of Engle (2002). The empirical results suggest that the EU3 stock markets are less affected when compared to the emerging markets because there was already higher market interdependence between the EU3 and the USA before the crisis. Second, the emerging markets have not been affected as immediately as the EU3 countries, although the effects have been more long-lasting albeit not permanent, falling as from 2013. Third, the EU index has a significant and greater volatility impact on BRIC-Turkey as compared to the crisis-originating country, the USA. However, the three CEE markets felt more impact from the USA. This is because the correlation between the three CEE markets and the EU index was already high, even before the GFC period. Fourth, we noted the dynamic evolution of the CEE markets have considerably changed and become more volatile from 2009 until the end of the sample, although they experienced a short calming period during the third quarter of 2011 due to ECB and IMF intervention, before then starting to increase again. Therefore, the impacts of the European sovereign debt crisis (ESDC) were stronger on the CEE markets than on BRIC-Turkey. Consequently, the second part of this thesis will investigate the degree to which the three CEE markets have been affected by the hard-hit GIPSI (Greece, Ireland, Portugal, Spain and Italy) countries and by the EU3. We include the EU3 in order to understand whether the spillover effect is greater within crisis borne countries or the EU3, which have more trade and financial ties with the three CEE countries. It is worth mentioning that the GFC resulted in the ESDC that broke out in 2009. Accordingly, the second part of this thesis examines the impacts of the ESDC and compares the post-ESDC period to the GFC period. Daily data in local currency is used from 3 May 2004 to 22 November 2013, involving splitting it into three sub-samples: pre-crisis (stable) period, GFC period, and ESDC/post period. Applying the same methodology as that used in the first part, the results are as follow. First, comparing the correlation to the pre-crisis (stable) period, there are substantial spillover effects during the GFC and ESDC; however, the impacts are felt more during the GFC. In addition to this, during the GFC the spillover effect is observed from all of the countries, unlike during the ESDC period. Second, due to strong trade and financial linkages, we found consistent strong market interdependences between EU3 and the CEE markets. Third, among the three CEE countries, the stock market of Poland showed a significantly higher level of average conditional correlation with EU3 when compared to Hungary and the Czech Republic. Fourth, the EU3 have a higher level of average correlation as compared to GIPSI, among the GIPSI countries, Spain and Italy have higher levels of correlations with the three CEE countries. Fifth, out of all the markets, Portugal remains the most contagious market (i.e. highest spillover effect) during both the GFC and the ESDC periods to all of the three CEE countries. Among the CEE markets, the most affected market is the Czech Republic. Finally from the policy perspective the study argues that policymakers should focus on improving fundamentals in order to enable them mitigate the shock. Keywords: Conditional Correlations, DCC-GARCH, Interdependence, Spillover effect, Contagion, Emerging markets, developed markets.