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Do structural breaks in volatility cause spurious volatility transmission?

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  • Caporin, Massimiliano
  • Malik, Farooq

Abstract

We show through extensive Monte Carlo simulations that structural breaks in volatility (volatility shifts) across two independently generated return series cause spurious volatility transmission when estimated with popular bivariate GARCH models. However, using a dummy variable for the induced volatility shift virtually eliminates this bias. We also show that structural breaks in volatility have a substantial impact on the estimated hedge ratios. We confirm our simulation findings using the US stock market data.

Suggested Citation

  • Caporin, Massimiliano & Malik, Farooq, 2020. "Do structural breaks in volatility cause spurious volatility transmission?," Journal of Empirical Finance, Elsevier, vol. 55(C), pages 60-82.
    • Handle: RePEc:eee:empfin:v:55:y:2020:i:c:p:60-82
    DOI: 10.1016/j.jempfin.2019.11.002
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    3. Belhassine, Olfa & Karamti, Chiraz, 2021. "Volatility spillovers and hedging effectiveness between oil and stock markets: Evidence from a wavelet-based and structural breaks analysis," Energy Economics, Elsevier, vol. 102(C).
    4. Malik, Farooq, 2021. "Volatility spillover between exchange rate and stock returns under volatility shifts," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 605-613.
    5. Pham, Son Duy & Nguyen, Thao Thac Thanh & Do, Hung Xuan, 2022. "Dynamic volatility connectedness between thermal coal futures and major cryptocurrencies: Evidence from China," Energy Economics, Elsevier, vol. 112(C).
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    7. Vatsa, Puneet & Basnet, Hem C., 2020. "The dynamics of energy prices and the Norwegian economy: A common trends and common cycles analysis," Resources Policy, Elsevier, vol. 68(C).
    8. Ewing, Bradley T. & Malik, Farooq & Payne, James E., 2024. "Volatility transmission between upstream and midstream energy sectors," International Review of Economics & Finance, Elsevier, vol. 92(C), pages 1191-1199.

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    More about this item

    Keywords

    Volatility; Structural breaks; GARCH;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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