Measuring the frequency dynamics of financial connectedness and systemic risk
Journal of Financial Econometrics, Volume 16, Issue 2, 2018
31 Pages Posted: 8 Jul 2015 Last revised: 27 Oct 2020
Date Written: December 15, 2017
We propose a new framework for measuring connectedness among financial variables that arises due to heterogeneous frequency responses to shocks. To estimate connectedness in short-, medium-, and long-term financial cycles, we introduce a framework based on the spectral representation of variance decompositions. In an empirical application, we document the rich time-frequency dynamics of volatility connectedness in US financial institutions. Economically, periods in which connectedness is created at high frequencies are periods when stock markets seem to process information rapidly and calmly, and a shock to one asset in the system will have an impact mainly in the short term. When the connectedness is created at lower frequencies, it suggests that shocks are persistent and are being transmitted for longer periods.
Keywords: Connectedness, frequency, spectral analysis, systemic risk
JEL Classification: C18, C58, G15
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