Equity Market Return Volatility: Dynamics and Transmission Among the G-7 Countries

Lori L. Leachman and Bill Francis

This paper studies the international transmission of equity market return volatility among the G-7 countries between April of 1973 and May of 1993. Using GARCH modeling, market return volatility is estimated for real returns of each country's stock index valued in US dollars. These volatility series are then employed to estimate a VAR system. Variance decomposition is calculated and impulse response functions are estimated in order to quantify and determine the directions of volatility transmission and the dynamic responses of each market to volatility shocks in the others. In general, results indicate a high level of volatility transmission among these markets, however, it is asymmetric. Evidence concerning the persistence of volatility shocks indicates that shocks take between six and twelve months to be accommodated. In addition, the empirical results indicate that the Plaza Accord affected volatility transmission. This result is consistent with policy coordination aimed at exchange rate management significantly impacting volatility interdependence and transmission of stock market returns. These results imply that future investigations of the relationship between domestic risk premia and market volatility should incorporate international influences on domestic asset risk.