Volatility Spillover Dynamics between Large-, Mid-, and Small-Cap Stocks in the Time-Frequency Domain: Implications for Portfolio Management

Abstract

The connectedness dynamics between large-, mid-, and small-cap stocks is investigated using the forecasted error variance decomposition (FEVD) spillover framework of Diebold and Yilmaz in the time-frequency domain. Total volatility spillover (i.e., connectedness) is elevated between large-, mid-, and small-cap stocks during the study period. This high level of spillover exists in the short run only, and declines gradually in the medium to long run, thus providing opportunities for portfolio diversification (hedging) in multi-cap investing during the medium-to-long run (short run) only. Like total connectedness, a similar pattern of bilateral connectedness is observed between either of the two indices, thus providing a similar opportunity in the short and long runs. The mid-cap index emerges as the major contributor to total volatility in the system, followed by the small- and large-cap indices, during the analyzed period. The volatility spillover is time-varying in both the time and frequency domains.

Spillovers and contagion between BRIC and G7 markets: New evidence from time-frequency analysis

“…It is important to note that the net-pairwise spillovers reduce in magnitude with increasing frequencies. In line with Jena, Tiwari, Dash, and Aikins Abakah [ 65 ], the findings (positive net-pairwise spillovers) are suggestive of the fact that diversification between BRIC and G7 equities can be profitable relative to between BRIC markets themselves. In the short term, we find India as the only BRIC country to be a recipient of net-pairwise spillover from the US.…”

“…For Brexit, the exit of Britain from the European Union might have caused a negative signal to international investors concerning their portfolio holdings. In responding to such a negative signal, all responses in the short term are attributable to transitory factors, which are likely to affect cross-market correlations [ 65 , 66 ], which then causes a significant change in the fundamental connectedness between developed and developing markets. Owusu Junior, Frimpong et al [ 34 ], Bossman [ 23 ], and Bossman [ 24 ] note that market dynamics and connectedness in the medium- (long-) term are attributable to key events (fundamental factors).…”

“…Information flows and spillovers are predominant in crises periods. Resultantly, due to the action(s) of rational, albeit irrational investors, any policy uncertainties that hit the market would be reacted to, leading to the emergence of short-lived connections within and across financial markets [ 65 , 66 ].…”

“…Generally, our results suggest that spillovers largely dominate in the short-term within high frequency/spillover bands 3.14~0.39. That is, the total spillovers existent between BRIC and G7 equities could be attributable to short-term transitory conditions [ 65 , 66 ]. Both markets are more likely to be immune to the shocks presented to financial markets globally during the COVID-19 pandemic, but they are less immune to the impacts of Brexit and the US-China trade tension.…”

The Dynamic Return and Volatility Spillovers among Size-Based Stock Portfolios in the Saudi Market and Their Portfolio Management Implications during Different Crises

“…Constructing two portfolios on the basis of the size of firms in the Spanish market, Marcelo et al (2008) found a bilateral volatility spillover that also vanishes when breaks are accounted for. Karmakar (2010) and Jena et al (2021) documented bilateral spillovers among large, medium, and small firms' returns and volatility in the Indian market.…”