Essays on Nonlinearities in Financial Market Co-movements

Abstract

The three self-contained essays that make up this thesis contribute to the study of nonlinearities in financial market co-movement in the context of three currently concerning global downside risk events: the financial vulnerability associated with cross-market liquidity dynamics, the interdependence of the equity and commodity markets, and the coronavirus disease (COVID) outbreak of 2019. Chapter 2 explores the impact that equity market volatility plays in the linkages between the U.S. equity and Treasury bond markets through liquidity under various regimes of investor sentiment. Using a threshold vector autoregression model, the baseline analysis demonstrates that the interaction between volatility and illiquidity dynamics coincides with the flight-to-safety phenomenon. Furthermore, empirical evidence in the optimistic investor sentiment regime suggests the potential existence of a flight-from-maturity phenomenon in which market players tend to reduce their lending maturities out of prudence. This result holds true whether the investor sentiment threshold value is chosen exogenously or endogenously. Further analysis confirms this relationship in the years following the Global Financial Crisis (GFC) and finds evidence of flight-from-maturity in the medium-term and short-term bond markets. Lastly, this chapter discovers that an equity market volatility shock increases the likelihood of transitioning from an optimistic to a pessimistic investor sentiment regime. The effect becomes more profound in the post-GFC era. Chapter 3 investigates the potential interdependence change between global equity markets and the commodity market across commodity cycles and discusses the driving factors behind it. Five commodity price cycles are identified using a cycle dating algorithm from January 1999 to May 2021, with peaks in November 2000, September 2005, July 2008, February 2012, and October 2018. The analysis proves that the interdependence between the commodity market and a large group of international equity markets changed between the expansionary and contractionary phases in all five cycles. It shows how each market's macroeconomic characteristics, such as the change in GDP per capita, manufacturing value-added, and net oil imports, affect the probability of an interdependence change. Chapter 4 empirically examines financial market contagion related to COVID among G20 equity markets. The sample period starts from the first officially reported case of COVID in China in December 2019 and ends on the night before the Omicron variant designation in November 2021. To show how contagion in the equity market might be tied to milestone events, pandemic waves, and global vaccination, this period is divided into six phases. Financial contagion triggered by the first officially reported COVID case and the WHO's pandemic announcement is by far more significant than financial contagion caused by subsequent waves of the pandemic. The results of Tukey's honestly significant difference test suggest that, particularly for those countries without a COVID outbreak, a higher vaccination rate may help counter financial contagion. Yet, for an individual country, there is no evidence for the linkages between the outbreak and financial contagion.