Sectoral and regional volatility connectedness : the case of EU and US indices

Abstract

This paper investigates sectoral and regional volatility connectedness across 22 equity sector indices – 11 for the US and 11 for Europe over 09/10/2001 – 31/12/2024. Daily price series are converted into log returns which are used to extract volatility using univariate GARCH models. The Diebold and Yilmaz (2012) framework is applied to measure the total, directional and pairwise spillovers. Furthermore, the paper looks at the dynamic volatility spillovers, highlighting how trends shift between stable periods and crisis periods. This research quantifies the magnitude and direction of volatility spillovers, identifying key transmitters and receivers and analyses the evolution of systemic risk across four sub-periods: the post dot-com recovery, the Global Financial Crisis (GFC) and subsequent Eurozone sovereign debt crisis, the post-crisis monetary easing era, and the recent shocks of the COVID-19 pandemic and the Russia-Ukraine war. The findings reveal a high degree of internal connectedness within both markets, however the key drivers of volatility differ. In the US, sectors like Consumer Staples and Materials are persistent net transmitters, whereas in the EU, Utilities and Financial services were the main transmitters. The cross-regional relationship is highly dynamic; while the US was the dominant net transmitter of shocks during the GFC, Europe became the primary source of volatility spillovers to the US during the 2022 energy and geopolitical crisis. However, although when both regions are combined the system is highly connected, the connectedness between the two markets is notably lower, with Europe acting as the net transmitter over the full sample. Cross-border spillovers are strongest within integrated industries. The analysis show that every major crisis led to a sharp increase in connectedness, both domestically and internationally confirming the contagion effects which diminishes the benefits of cross-sector and cross-regional diversification. Furthermore, a structural shift after the GFC was established of due to higher integration across markets.