The Changing Role of Financial Stress, Oil Price, and Gold Price in Financial Contagion among US and BRIC Markets

Published date01 September 2019
AuthorUgur Soytas,Ramazan Sari,Ecenur Ugurlu,Baris Kocaarslan
Date01 September 2019
The Changing Role of Financial
Stress, Oil Price, and Gold Price in
Financial Contagion among US and
BRIC Markets
Department of Business Administration, Middle East Technical University, Ankara,
Turkey and
Department of International Trade and Business, Yildirim Beyazit University, Ankara,
The objective of this paper is to explore the determining factors behind
nancial contagion between US and BRIC (Brazil, Russia, India, and China)
equity markets. To this end, we investigate the effects of global macroeco-
nomic factors on the time-varying correlations among these markets
obtained by asymmetric dynamic conditional correlation method. Utilizing
quantile regression analysis, we examine the determinants of nancial conta-
gion at different levels of time-varying correlations. The results of quantile
regression analyses reveal that global nancial crisis (GFC) (2008) leads to
changes in the dependence structure between dynamic conditional correla-
tions among equity markets and global macroeconomic factors, such as
global nancial stress, oil prices, and gold prices. Following the GFC, mone-
tary, and scal policy changes in the BRIC markets and hence changing mac-
roeconomic risks of these markets are conducive to these changes. Our
ndings also demonstrate the importance of cross-market rebalancing chan-
nel for information transmission across US and BRIC markets.
JEL Codes: F30; G15; C58
Accepted: 16 March 2018
The spread of nancial shocks from one country to others is called contagion.
The nancial contagion among global markets has important consequences for
global market players, speculators, investors, and policy makers (Longin and
Solnik 1995; Ang and Bekaert 1999; Forbes and Rigobon 2002; Chiang
et al. 2007; Dooley and Hutchison 2009). The contagion literature reveals the
importance of two types of contagion: fundamental based-contagion and
investor-behavior contagion (Masson 1998; Dornbusch et al. 2000; Forbes and
Rigobon 2001). The former is related to contagion among markets based on
© 2018 International Review of Finance Ltd. 2018
International Review of Finance, 19:3, 2019: pp. 541574
DOI: 10.1111/ir.12189
trade and nancial linkages between markets. Goldstein (1998) addresses
wake-up callhypothesis which argues that the fundamental characteristics of
countries may play an important role on nancial contagion since investors
tend to reevaluate the susceptibility of a market to crises in other markets.
Bekaert et al. (2014) nd evidence that wake-up calls drive nancial contagion
during the global economic crisis (2008). The latter is caused by shifts in inves-
torsrisk appetites and risk perceptions, which lead to changes in the
asset allocation strategies of global investors. If there is an increase in the risk
appetite of global investors, investors are inclined to invest in more risky assets
in international markets. These trends lead to increases in the prices of risky
assets across global markets. This type of contagion is generated by changes in
global investorsportfolio structure rather than by the marketscharacteristics
(Kumar and Persaud 2001).
The dynamic nature of information ows has an impact on market equilib-
rium prices and global portfolio diversication strategies. Fleming et al. (1998)
argue that not only common information simultaneously inuences expecta-
tions across markets but also cross-market hedging leads to information spill-
overs. Investors who trade in the stock markets are affected by an information
event that directly or indirectly alters their expectations about a market. The
information ow arising from both common information and cross-market
hedging in return leads to increased linkages across markets. However, several
practical considerations and institutional constraints may limit the effect of
cross-market hedging (Fleming et al. 1998). Kodres and Pritsker (2002), in a
study on contagion channels, argue that nancial contagion among global mar-
kets varies with their exposures to the shared macroeconomic risks and the
amount of information asymmetry in these markets. The tendency of rebalan-
cing global portfolios increases with the amount of information asymmetry
concerning risky markets, such as emerging markets where the amount of infor-
mation asymmetry is very high. Simultaneous trading activities resulting from
cross-market rebalancing enhance information linkages across equity markets
and ultimately generate nancial contagion among them over time.
With the increase in globalization during the last decades, the correlations
between the risks of countries, global factors, and the stock marketsperfor-
mances have attracted a lot of interest (Forbes and Rigobon 2002; Abad
et al. 2010). Most of the studies in the literature show that the benet of inter-
national diversication is reduced as more nancial integration leads to an
increase in the correlations of global market returns (Longin and Solnik 1995).
Several studies investigate the time-varying cross-market correlations, especially
at the time of an economic crisis. During a crisis period, there are intensied
linkages among global markets (Cappiello et al. 2006; Aloui et al. 2011; Akca
and Ozturk 2016).
Although most of the early studies on contagion mainly focus on mature
markets rather than emerging markets, recently the number of studies on
emerging markets focusing on the time-varying cross-market correlations have
increased (Bekaert and Harvey 1995; Chen et al. 2002; Cappiello et al. 2006;
© 2018 International Review of Finance Ltd. 2018542
International Review of Finance
Carrieri et al. 2007.; Chiang et al. 2007; Kenourgios et al. 2011; Choe
et al. 2012). In fact, as De Jong and De Roon (2005) state, for the emerging mar-
kets, the dynamic nature of integration is more apparent than mature markets.
This may be due to the fact that they are progressively integrating into the
international markets. Time-varying nature of comovements across markets is
important for global portfolio management because it may have different impli-
cations for long-term- and short-term-oriented investment strategies of inves-
tors. Investors with different risk tolerances should consider time-varying
characteristics of correlations across market returns. Short-term dynamics
among markets concern active investors such as large investment banks
whereas the individuals, insurance companies, and commercial banks are more
interested in long-term dynamics between markets as passive investors
(Lehkonen and Heimonen 2014).
There have been several studies that identify important macroeconomic vari-
ables for equity returns and cash ows, such as business cycle patterns, future
production growth rates, dividend yields, and interest rates (Fama 1990; Schwert
1990; Longin and Solnik 1995). The role that global macroeconomic factors play
in determining the time series pattern of dynamic correlations across global mar-
kets has vital importance on hedging activity. The impacts of these macroeco-
nomic factors work via changes in investor expectations. Shifting funds across
global markets happens selectively when global investors expect information
linkages among markets to change over time based on the global conditions.
During the good times of global economies, the role of information asymmetry
in nancial contagion could not be critical since global economic conditions are
stable, which likely leads to much less hedging activity (Kodres and Pritsker
2002). On the other hand, during the times of crisis, the increase in hedging
demand results in changes in correlation dynamics across global markets. But
the same is true for alternative markets. As global investors closely follow alter-
native investment areas, what happens in those markets may have signicant
inuences on how they form investorsexpectations. Ultimately, a change in
the strategies followed by global investors will have an impact on the correla-
tions among global stock markets depending on investorsexpectations.
There has been little research on the determinants of nancial contagion
between markets. This study aims to shed light on the determinants of dynamic
correlations among US and BRIC (Brazil, Russia, India, and China) equity mar-
kets. To that respect, two alternative markets are taken into account. Several
important studies reveal that the gold market is sometimes considered as a safe
haven during turbulent periods (Jaffe 1989; Lawrence 2003; Arouri and Nguyen
2010; Baur and McDermott 2010; Daskalaki and Skiadopoulos 2011). In addi-
tion, the gold market can be considered as a representative of the precious
metals markets. The second alternative investment area is the oil market. There
is a huge literature on the links between oil and nancial markets including
BRIC markets. This literature provides abundant evidence of price and volatility
spillovers between these markets (Bhar and Nikolova 2009; Kang et al. 2009;
Fang and You 2014). Oil can also be thought of as a leading commodity. Other
© 2018 International Review of Finance Ltd. 2018 543
The Role of Global Factors in Financial Contagion

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