Identification of Global and Local Shocks in International Financial Markets via General Dynamic Factor Models

33 Pages Posted: 20 Mar 2017 Last revised: 28 Nov 2017

See all articles by Matteo Barigozzi

Matteo Barigozzi

London School of Economics and Political Science

Marc Hallin

ECARES, Universite Libre de Bruxelles

Stefano Soccorsi

Department of Economics, Lancaster University Management School

Date Written: November 27, 2017

Abstract

We employ a two-stage general dynamic factor model to analyze co-movements between returns and between volatilities of stocks from the US, European, and Japanese financial markets. We find two common shocks driving the dynamics of volatilities – one global shock and one US-European shock – and four local shocks driving returns, but no global one. Co-movements in returns and volatilities increased considerably in the period 2007-2012 associated with the Great Financial Crisis and the European Sovereign Debt Crisis. We interpret this finding as the sign of a surge, during crises, of interdependencies across markets, as opposed to contagion. Finally, we introduce a new method for structural analysis in general dynamic factor models which is applied to the identification of volatility shocks via natural timing assumptions. The global shock has homogeneous dynamic effects within each individual market but more heterogeneous effects across them, and is useful for predicting aggregate realized volatilities.

Keywords: Dynamic factor models, volatility, financial crises, contagion, interdependence

JEL Classification: C32, C55, C38, G01, G15

Suggested Citation

Barigozzi, Matteo and Hallin, Marc and Soccorsi, Stefano, Identification of Global and Local Shocks in International Financial Markets via General Dynamic Factor Models (November 27, 2017). Available at SSRN: https://ssrn.com/abstract=2937243 or http://dx.doi.org/10.2139/ssrn.2937243

Matteo Barigozzi (Contact Author)

London School of Economics and Political Science ( email )

Houghton Street
London, England WC2A 2AE
United Kingdom

Marc Hallin

ECARES, Universite Libre de Bruxelles ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
Brussels, B-1050
Belgium
+32 2 650 5886 (Phone)
+32 2 650 5899 (Fax)

Stefano Soccorsi

Department of Economics, Lancaster University Management School ( email )

Lancaster, LA1 4YX
United Kingdom

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