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Volatility co-movements: A time-scale decomposition analysis

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  • Cipollini, Andrea
  • Cascio, Iolanda Lo
  • Muzzioli, Silvia

Abstract

In this paper, we are interested in detecting contagion from US to European stock market volatilities in the period immediately after the Lehman Brothers collapse. The analysis is based on a factor decomposition of the covariance matrix, in the time and frequency domain, using wavelets. The analysis aims to disentangle two components of volatility contagion (anticipated and unanticipated by the market). Once we focus on standardized factor loadings, the results show no evidence of contagion (from the US) in market expectations (coming from implied volatility) and evidence of unanticipated contagion (coming from the volatility risk premium) for almost any European country. Finally, the estimation of a three-factor model specification shows that a European common shock plays an important role in determining volatility co-movements mainly in the tranquil period, while in the period of financial turmoil, the US common shock is the main driver of volatility co-movements.

Suggested Citation

  • Cipollini, Andrea & Cascio, Iolanda Lo & Muzzioli, Silvia, 2015. "Volatility co-movements: A time-scale decomposition analysis," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 34-44.
    • Handle: RePEc:eee:empfin:v:34:y:2015:i:c:p:34-44
    DOI: 10.1016/j.jempfin.2015.08.005
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    More about this item

    Keywords

    Implied volatility; Realized volatility; Volatility risk premium; Contagion; Heteroskedasticity bias; Wavelets;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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