Financial market integration, contagion and volatility transmission: a case of the globally developed markets and developing stock markets in Africa

The widespread impact of the 2007 global financial crisis and the subsequent Eurozone sovereign debt crisis added new impetus to the on-going international discussions about the sustainability of a financial integration model. Moreover, the crisis revealed the complexity of the international transmission of financial shocks and the financial vulnerabilities of different financial markets. More so, it exposed the major weaknesses in our knowledge of how the forces that drive global financial systems operate. This is compounded by a failure to appreciate the scope of interdependencies that exist across markets and their potential to destabilise the global financial system in times of crises. At the heart of this weakness is the inability to accurately understand the various propagation mechanisms and channels through which a crisis from one market is transmitted to other markets. It is against this background that this study is undertaken, in order to empirically investigate the role of financial market integration, contagion and volatility transmission, using weekly data between the period 3 January 2003 to 26 December 2014. The study covers 27 stock markets, comprising 13 African stock markets, 10 developed stock markets and four emerging stock markets. The study employed two empirical frameworks: the first framework focused on the short-run and long-run relationships between African stock markets and major global stock markets using the Johansen co-integration test, Granger causality test, GIRF and GFEVD. The second framework focused on testing evidence of contagion and volatility transmission using the DCC-GJRGARCH model and AS model. The results show that the majority of African stock markets moved together in the long-run with the major global stock markets during the pre-crisis and Eurozone crisis periods. While the long-run relationship between African stock markets and the major global markets disappeared during the period of the global financial crisis, the relationship re-emerged during the Eurozone crisis period. From the analysis of Granger causality test, the results show some differences exist in terms of the relative strength of the causal linkages across markets and periods. However, it was shown that strong causal linkages emerged during the global financial and Eurozone crisis periods relative to the pre-crisis period. Also, the leading role of the major developed markets, compared to the emerging markets, is demonstrated throughout the analysis of causality tests. Moreover, the sensitivity of African markets to shocks from the global markets was clearly highlighted by analysis of the GIRF and GFEVD, especially during both crisis periods. Furthermore, the results from the AS model confirm significant evidence of mean and volatility spill-over effects from the major global markets to African markets especially during the periods of both crises. In addition, the level of volatility was found to be more persistent and asymmetric during both crisis periods compared to the pre-crisis period. The results…