Return and volatility transmissions in international financial markets: Nonlinear approaches

Since the introduction of ARCH model by Engle (1982), the literature in financial markets interdependence has been extended to examine both mean and second moment properties of stock returns. This paper provides additional evidence of market interdependence with the main argument that relationship among markets is better described by nonlinear process. Applying nonlinear MARS and GAM to each stage of the GARCH two-step procedure, returns and volatility equations of thirteen selected stock markets; five Asian emerging markets and eight developed markets in North America, Europe and Asia, have been estimated and pattern of stock return and volatility transmissions have been addressed. Both weekly and daily data of stock return index have been used and their results were compared and contrasted. The long horizon data range from 1988 to 2009 make possible the investigation of structural change in market linkages after the 1997 Asian crisis.;Nonlinear estimation in both return and volatility equations yield higher explanatory power especially after Asian crisis. MARS and GAM indicate significant nonlinear and asymmetric effects in both return and volatility transmission process. While the results from OLS estimation are consistent with the stylized fact such that United States is the most significant market influencing stock returns in other countries and important exporter of shocks, results of MARS and GAM imply regional integration. Examining with daily data, it appears that return transmission follows the order of market closing time and international financial markets move toward informational efficiency after Asian crisis. Volatility process exhibits persistent and volatility transmission mechanism can be categorized as "heat waves" in Taiwan, Malaysia, Switzerland and United Kingdom while after Asian crisis, the volatility spillovers with "meteor showers" effect prevail in Germany, France, United States, Japan, Hong Kong, Korea, Singapore, Thailand and Indonesia.