Risk Aversion Connectedness in Developed and Emerging Equity Markets before and after the COVID-19 Pandemic

Abstract

This study investigates the dynamic connectedness across the variance risk premium in international developed and emerging equity markets based on a Bayesian time-varying parameter vector autoregressive methodology.

The empirical results indicate that the total spillover index is on average 65.6%, indicating a high, albeit declining, level of interconnectedness across the investor sentiment in the three markets under review until early 2020. Following the COVID-19 outbreak though, the total investors' risk aversion connectedness – as expected – strengthens, but more importantly, its dynamics alter, indicating that the risk aversion of emerging markets is an important contributor to the connectedness of international markets.

Keywords: variance risk premium; Diebold and Yilmaz; spillovers; emerging markets; risk aversion; TVP-VAR; COVID-19

JEL Classification: C32, G10, G13, G15, G41