Stock Market TVP-VAR Dynamic Connectedness and VIX Shocks Spillovers: Evidence from a Sectoral Analysis of the Fragile Five

Abstract

Objective: This study investigates the cross-sectoral spillover effect and the contribution of the volatility index (VIX) in the transmission of shocks in the Fragile Five (Brazil, India, Indonesia, South Africa, and Turkey). Research Design & Methods: We focused on the role played by the various sectors of the economy (Energy, Financials, Industrials, Basic Materials, and Real Estate) and the VIX in the crisis propagation, i.e. whether they act as sources, transmitters or receivers of financial stress, following the time-varying parameter vector autoregression (TVP-VAR) approach. The study also highlights the dynamic evolution of contagion across time. Findings: We identified the financial sector (essentially the largest in terms of market value) as a strong net transmitter. Another relatively strong net transmitter was the industrial sector (medium-sized). Basic Materials (medium-sized) and Real Estate (the smallest in terms of market value) essentially acted as net receivers. In all the countries surveyed, Energy (medium-sized sector) and the VIX were identified as net receivers. We found that the bidirectional spillover between the VIX and sectoral indices was weak in all countries under investigation. Our observations on the VIX behaviour can be associated with the fundamentals, such as the US/the Fragile Five equity market mutual exposures, but we opted for the neutrality of the relationship between the VIX and sectoral indices. The average Total Connectedness Index (TCI) in the Fragile Five turned out to be relatively low. We also observed that sharp increases in the TCI were associated with market tensions, both country-specific and global. Implications & Recommendations: Our conclusions can help formulate economic policy goals and increase the efficiency of portfolios with exposures in the Fragile Five countries. Risk transmitters such as the financial and industrial sectors should be closely watched by regulators and investors with exposures to risk takers, i.e. sectors such as Energy, Basic Materials, and Real Estate. Sharp increases in the TCI related to market tensions should be a warning signal when formulating economic policy goals and building investment strategies. Determining the role of fear indices in the spillover mechanism, including the VIX, requires additional in-depth empirical studies. Contribution & Value Added: Our contribution to the literature is threefold. Primarily, to our knowledge, it is the first study to provide insights into the linkages between the different sectors of the Fragile Five economies and the volatility index. Secondly, unlike the vast majority of previous work focused on sectoral linkages in selected groups of emerging economies taken as a whole, we draw common conclusions for the Fragile Five based on observations of their individual economies, which helped to reduce the number of generalizations. Thirdly, through the inference process, we identified some interesting correlations that could be a starting point for further research.

Keywords

• contagion effect
• cross-sectoral spillover
• Fragile Five
• shock transmission
• TVP-VAR