The Dynamics of Cross-Boundary Fire - Financial Contagion between the Oil and Stock Markets

32 Pages Posted: 27 Aug 2020

See all articles by Haiying Wang

Haiying Wang

Independent

Ying Yuan

Northeastern University - School of Business Administration

Tianyang Wang

Colorado State University - Department of Finance & Real Estate

Date Written: August 23, 2020

Abstract

Motivated by the complex dynamics between the oil and stock markets, this study develops a dynamic Markov regime switching-copula-extreme value theory (MRS-copula-EVT) model to quantitatively investigate financial contagion and its characteristics between these two markets. The proposed model, which characterizes the complex dynamics in lower tail dependence, is applied to daily returns on the crude oil price and major stock indices in both the United States and China's markets over a series of major extreme downside risk events, including the most recent 2020 oil and stock market crashes after the outbreak of COVID-19 pandemic. The proposed model outperforms the alternative model in detecting financial contagion, showing that such contagion is shorter but stronger in the United States than in China; moreover, financial contagion is more susceptible to extreme downside shocks between the oil and stock markets in the United States than in China. In addition, the COVID-19 crisis shows the largest financial contagion compared with previous crises. Our results remain consistent following extensive robustness tests. These findings shed new light on our understanding of financial contagion and provide important insights and guidance for asset allocation and risk management.

Keywords: Financial Contagion, Oil Market, Copula, Extreme Value Theory, COVID-19

JEL Classification: C5; G1

Suggested Citation

Wang, Haiying and Yuan, Ying and Wang, Tianyang, The Dynamics of Cross-Boundary Fire - Financial Contagion between the Oil and Stock Markets (August 23, 2020). Available at SSRN: https://ssrn.com/abstract=3679656 or http://dx.doi.org/10.2139/ssrn.3679656

Haiying Wang

Independent ( email )

Ying Yuan

Northeastern University - School of Business Administration ( email )

Shenyang, 110004
China

Tianyang Wang (Contact Author)

Colorado State University - Department of Finance & Real Estate ( email )

Finance and Real Estate Department
1272 Campus Delivery
Fort Collins, CO 80523
United States

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