Spillovers and financial integration in emerging markets: Analysis of BRICS economies within a VAR‐BEKK framework

• Author: Saswat Patra,Pradiptarathi Panda
• Published date: 01 January 2021
• Date: 01 January 2021
• DOI: http://doi.org/10.1002/ijfe.1801

RESEARCH ARTICLE

Spillovers and financial integration in emerging markets:

Analysis of BRICS economies within a VAR-BEKK

framework

Saswat Patra

1

| Pradiptarathi Panda

2

1

Department of Finance, S. P. Jain

Institute of Management and Research,

Bhavan Campus, Mumbai, Maharashtra,

India

2

Department of Finance, National

Institute of Securities Market, Raigad,

Maharashta, India

Correspondence

Saswat Patra, S. P. Jain Institute of

Management and Research, Bhavan

Campus, Munshi Nagar, Andheri (W),

Mumbai, Maharashtra 400058, India.

Email: saswat195@gmail.com

Abstract

This study estimates the return and volatility spillovers among the BRICS

countries (internal) and between BRICS, gold, oil and US stock markets (exter-

nal). We find that internal return and volatility spillovers are higher than their

external spillover counterparts. Thus, investors would be better off diversifying

their investments in gold, oil and US stock markets along with the emerging

economies. Interestingly, we also find that the return spillovers are higher than

their volatility spillover counterparts, thus presenting investors with an oppor-

tunity to diversify their portfolio risk. With respect to portfolio constitution,

South Africa emerges as the top choice for investment within the BRICS,

whereas gold is the preferred choice for investors outside the BRICS

economies.

KEYWORDS

BRICS, financial contagion, spillovers, VAR-BEKK

JEL CLASSIFICATION

F30; G11; G15; O16

1|INTRODUCTION

Portfolio diversification and emerging markets are subjects

that have intrigued investors all over the world, especially in

recent times when the world has become more globalized

than ever. While globalization has opened up the financial

markets to international investors leading to financial inte-

gration across capital markets, it has also increased the risk

of market collapses, especially with financial crashes in one

market spilling over to the other markets. Globalization and

higher level of financial integration result in higher correla-

tion between capital markets (Aloui, Aïssa, & Nguyen, 2011).

This integration impacts international portfolio diversifica-

tion and hedging (Carrieri et al, 2007).

This study examines the internal spillover among

BRICS countries and also the external spillover between

oil, gold and US stock markets and BRICS countries with

respect to return and volatility. It offers some interesting

insights with respect to the spillover phenomenon. We

find that the return spillover was at its peak during the

global recession, thereby supporting the concept of finan-

cial contagion; however, interestingly enough, the same

is not true for volatility spillovers, thus providing an

opportunity for the investors to diversify their portfolio.

Furthermore, in general, we find that the return spill-

overs exceed the volatility spillovers throughout this

study and while strong integration can be observed in the

level, similar evidence is lacking in the case of volatility.

We also find that the diversification between the BRICS

countries and gold, oil and US stock markets is a better

strategy for the investors than diversification within the

BRICS economies. Furthermore, we find that the

Received: 29 June 2018 Revised: 16 October 2018 Accepted: 13 September 2019

DOI: 10.1002/ijfe.1801

Int J Fin Econ. 2019;1–22. wileyonlinelibrary.com/journal/ijfe © 2019 John Wiley & Sons, Ltd. 1

Int J Fin Econ. 2021;26:493–514. wileyonlinelibrary.com/journal/ijfe © 2019 John Wiley & Sons, Ltd. 493

information transmission and integration in the financial

markets after the global recession is high when compared

with the pre-recession era.

In our study, we use a VAR-BEKK framework to esti-

mate the spillovers in return and volatility. Unlike previ-

ous studies which have used a VAR-BEKK framework in

a pair-wise setting, we model all countries simulta-

neously. This provides us with a better understanding of

the spillovers unlike the previous studies wherein only

the marginal impacts were considered or estimated.

Global investors consider BRICS as a good destination

for portfolio diversification (Naresh, Vasudevan,

Mahalakshmi, & Thiyagarajan, 2017). Dominic, W., &

Roopa, P. (2003) suggest that owing to the high growth

rate compared to the other countries, BRICS countries

are expected to outperform most of the developed coun-

tries in the world by 2050. The growth in aggregate

investment increases mainly due to financial and eco-

nomic liberalization (Henry, 2000). The official liberaliza-

tion of these countries started in the 1990s: Brazil (May

1991), Russia (January 1994), India (February 1992),

China (July 1993) and South Africa (1996). This could be

another reason for interdependence among the BRICS

countries. However, whether one stock market crowds

out or complements the other stock market in the wake

of new information is yet to be seen. Previous studies

consider only BRIC countries for their analysis;

South Africa is the late entrant to the group (in December

2010), we consider BRICS countries in our study.

This study is timely and relevant as BRICS countries

are growing faster than the rest of the world and can pro-

vide excellent opportunities for investors to achieve a

higher return on their investments along with the bene-

fits of diversification. Over the last decade, the BRICS

economies have witnessed tremendous and unparalleled

growth. With respect to GDP, China (11.006) leads the

BRICS economies followed by India (2.035), Brazil

(1.772), Russia (1.332) and South Africa (0.313).

1

The

average annual GDP (real) growth rate for BRICS coun-

tries in the last 20 years (1996–2016) has been in the

range of 3–10% with Brazil registering the least (around

2.5%) and China registering the highest (9.5%). During

the same period, the US GDP has grown at about 2.4%

only. With respect to market capitalization, the share of

BRICS countries in the world has increased to 14.69% of

which China has the maximum share (9.71%) followed

by India (2.34%), Brazil (1.13%), Russia (0.89%) and

South Africa (0.63%)

2

. Based on the Buffett Indicator, we

find the United States and South Africa stock markets to

be overvalued as their market capitalization to GDP ratio

is above 1 (1.17 and 1.01, respectively). Markets in Brazil

(0.19), Russia (0.19), India (0.74) and China (0.68), on the

other hand, are undervalued.

2

The undervaluation

attracts investors to invest in these markets as there is

huge potential to get higher returns. Diversification for

foreign investors in these countries will yield economic

value. The average annual growth rate

3

in the last

20 years for Brazil and Indian stock markets has been

around 17%—for Russia, it is 30%, China 13% and

South Africa 14%, while for the United States, the

corresponding growth rate is only 5%. This suggests that

BRICS countries have been a popular choice for the

investors in recent times. Sessions of all the BRICS coun-

tries' stock markets also follow similar patterns like pre-

open, normal trading hours, closing and post-closing

sessions.

The potential that the BRICS countries offer to the

investors is huge. These countries have a combined popu-

lation of 3.1 billion people, which is approximately 42%

of the world population. Further, these countries have a

very high proportion of youth population as well (approx-

imately 1 billion or 30% of their total population)

1

. The

net foreign portfolio investment for India (7.88),

South Africa (1.418) and Russia (0.894) is positive while

it is negative for China (−63.752)

4

owing to heavy regula-

tions. FDI inflows to China were the largest (126.267)

followed by Brazil (75.075), India (55.457), Russia

(22.891) and South Africa (1.774), thereby strengthening

our argument that BRICS countries are an attractive des-

tination for investors.

5

Over the years (2010–2017), the inflation for BRICS

economies has reduced. While for Brazil, inflation fell

from 5.91% to 2.95%, for Russia, the decline was even

higher (8.80% to 2.50%). During the same period, infla-

tion in India toppled to 2.3% from 9.47%. However, infla-

tion for South Africa has remained more or less stable in

the range of 3.5 to 4.6%. Inflation in China is also at its

all-time low of 1.8%.

6

Trade relations among the BRICS countries are very

strong. In the cases of Brazil and South Africa, the other

members of the BRICS contribute about a quarter

(25 and 27%, respectively) of the total trade. For Russia

and India, the contribution to the total trade by the mem-

bers of the BRICS countries is about 17 and 15%, respec-

tively. This hints at possible spillover effects in the case of

the financial markets as well.

The annual consumption of gold and oil in the world

has increased tremendously over the last decade, and the

same is noticeable in Figure 1a,b. India and China are

the largest consumers of gold in the world. The average

contribution of gold consumption in BRICS countries to

World gold consumption has been about 54% for the last

7 years (from 2010 to 2016) of which India and China

together contribute over 50%. Similarly, in the case of oil,

we find the average oil consumption of the BRICS coun-

tries over the last decade is about a quarter of the world's

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