A Direct Approach to Cross Market Spillovers

Abstract

This paper introduces a framework that directly quantifies information spillovers between financial markets. Information spillovers occur when market specific information, defined as information that directly affects the return or volatility in one market only, indirectly affects returns or volatility in other markets through some channel(s) of transmission. By using market specific order flow as a measure of market specific information, we estimate the spillover effects from the stock market to the bond market and vice versa. We examine spillovers under different market conditions by employing a regime-switching framework. We find evidence of spillovers in returns and volatility across the two markets especially when the volatility in the stock market is high. Our findings are consistent with flight-to-quality and rebalancing as channels of transmission.

Keywords: Cross Market spillovers, Regime-switching, Market Microstructure

JEL Classification: G12, G14