Spreading the Fear: The Central Role of CBOE VIX in Global Stock Market Uncertainty

Abstract

Construction of efficient portfolios is reliant on understanding the correlation between assets. If correlations change markedly during times of economic turmoil then investors are exposed to greater than desired risk levels at the most inopportune time. We examine the linkages between global stock markets using measures of market uncertainty (implied volatility). Using a sample of daily changes in G7 and BRIC implied volatility measures, over a 20-year sample period, we demonstrate that uncertainty in U.S. markets plays a pivotal role in global stock market uncertainty. “Fear is spread” across markets, as heightened uncertainty in U.S. markets is transmitted across global markets. Conversely, global markets do not appear to explain innovations in U.S. market uncertainty. While there is a clear increase in inter-dependence during crisis periods, we observe a disparity in the way that inter-dependencies change during the two major economic crises in our sample period; the GFC (2007-2009) and COVID-pandemic (2020). The additional importance of US news largely drives the result during the GFC, while the effect is more widespread (particularly within European markets) during COVID.

Keywords: Market uncertainty, Investor fear, Implied volatility, VIX, Linkages, COVID

JEL Classification: G10, G14, G15