Financial and Macroeconomic Connectedness ─ A Network Approach to Measurement and Monitoring

Connections among different assets, asset classes, portfolios, and the stocks of individual institutions are critical in examining financial markets. Interest in financial markets implies interest in underlying macroeconomic fundamentals. InFinancial and Macroeconomic Connectedness, Frank Diebold and Kamil Yilmaz propose a simple framework for defining, measuring, and monitoring connectedness, which is central to finance and macroeconomics. These measures of connectedness are theoretically rigorous yet empirically relevant.

The approach to connectedness proposed by the authors is intimately related to the familiar econometric notion of variance decomposition. The full set of variance decompositions from vector auto-regressions produces the core of the 'connectedness table.' The connectedness table makes clear how one can begin with the most disaggregated pair-wise directional connectedness measures and aggregate them in various ways to obtain total connectedness measures. The authors also show that variance decompositions define weighted, directed networks, so that these proposed connectedness measures are intimately related to key measures of connectedness used in the network literature.

After describing their methods in the first part of the book, the authors proceed to characterize daily return and volatility connectedness across major asset (stock, bond, foreign exchange and commodity) markets as well as the financial institutions within the U.S. and across countries since late 1990s. These specific measures of volatility connectedness show that stock markets played a critical role in spreading the volatility shocks from the U.S. to other countries. Furthermore, while the return connectedness across stock markets increased gradually over time the volatility connectedness measures were subject to significant jumps during major crisis events.

This book examines not only financial connectedness, but also real fundamental connectedness. In particular, the authors show that global business cycle connectedness is economically significant and time-varying, that the U.S. has disproportionately high connectedness to others, and that pairwise country connectedness is inversely related to bilateral trade surpluses.

Francis X. Diebold is Paul F. and Warren S. Miller Professor of Economics, and Professor of Finance and Statistics, at the University of Pennsylvania and its Wharton School. He has published widely in econometrics, forecasting, finance, and macroeconomics, and he has served on the editorial boards of leading journals including Econometrica, Review of Economics and Statistics, Journal of Business and Economic Statistics, Journal of Applied Econometrics, and International Economic Review. He is an NBER Faculty Research Associate, as well as an elected Fellow of the Econometric Society, the American Statistical Association, and the International Institute of Forecasters. He has also been the recipient of Sloan, Guggenheim, and Humboldt fellowships; Co-Director of the Wharton Financial Institutions Center; and President of the Society for Financial Econometrics. His academic research is firmly linked to practical matters: During 1986-1989 he served as an economist under both Paul Volcker and Alan Greenspan at the Board of Governors of the Federal Reserve System, during 2007-2008 he served as an Executive Director of Morgan Stanley Investment Management, and during 2012-2013 he served as Chairman of the Federal Reserve System's Model Validation Council. Diebold also lectures widely and has held visiting professorships at Princeton, Chicago, Johns Hopkins, and NYU. He has received several awards for outstanding teaching, and his academic "family" includes nearly 75 Ph.D. students.

Kamil Yilmaz holds PhD (1992) and MA (1990) degrees in Economics from the University of Maryland, College Park, and a BA degree in Economics from Bogazici University, Istanbul, Turkey (1987). He has been a faculty member at Koc University, Istanbul, Turkey, since 1994. He was a visiting professor at the University of Pennsylvania in 2003-2004 and 2010-2011 academic years. He is the recipient of the 2003 Turkish Academy of Sciences (TUBA) Encouragement Award for Social Sciences; and a member of the American Economic Association, and the Econometric Society. His areas of research include financial econometrics, international economics and macroeconomics.