RDP 9609: Australian Financial Market Volatility: An Exploration of Cross-Country and Cross-Market Linkages 6. Conclusion

An analysis of daily asset price fluctuations in Australia's bond, share and foreign exchange markets over the period 1987 to 1996, does not suggest the presence of a trend increase in Australian financial market volatility. Episodes during which volatility records quite sizeable increases can be observed. These episodic surges in volatility however are not maintained. Rather they are generally short-lived events, with volatility returning relatively quickly to its underlying or background level.

With respect to each of the key Australian financial markets, the following general observations can be made regarding their respective volatility profiles.

Daily volatility in the Australian bond market is higher on average than other markets, and displays greater variability over time. While econometric tests suggest the presence of a slight positive trend in volatility, this is probably a statistical consequence of the high and relatively persistent volatility episode late in the sample period, rather than evidence of a trend increase.

No secular upward trend can be observed in daily Australian share-market volatility. To the contrary, econometric tests and visual inspection of the data suggest the presence of a slight downward trend in Australian share-market volatility over the period. This is a feature shared by other national markets, with the exception of the Japanese stock market. In contrast to the bond market, Australian share-market volatility is not high in international terms and comparable to the US and UK market averages.

The volatility of daily percentage changes in the USD/AUD exchange rate records the lowest period average out of the five currencies that are examined. Econometric tests as well as visual inspection, reveal a clear downward trend in the volatility profile of the USD/AUD nominal exchange rate. These tests however also reveal a slight positive trend in the volatility of the TWI, possibly reflecting the higher volatility of the JPY/USD exchange rate in recent years.

With regard to the issue of cross-country and cross-market linkages, the following general results emerge. Correlation analysis and econometric tests provide evidence of quite significant cross-country ‘contagion’ or ‘spillover’ effects impacting on Australia's bond and equity markets. For both of these markets, the predominant foreign market influence is the US. For the Australian bond market, an increasing dependence on daily yield fluctuations in the US bond market is clearly evident. This pronounced spillover effect from the US to Australian bond markets, however, becomes readily apparent only from late 1993 onwards. The evidence also seems to suggest that this increased responsiveness displayed by the Australian bond market to overnight changes in US bond yields is not a transient event, but, rather, a structural change in the relationship between the two markets.

Significant spillover effects from the US to Australian equity markets also exist. Unlike the case for bond markets however, daily price fluctuations in the US share market have an important influence on Australian share prices throughout the nine year sample period. The magnitude of ‘contagion’ is not constant over time, its variation over the period is quite significant with spillovers becoming most pronounced during episodes of severe financial market turbulence.

Extending the examination to explicitly consider both cross-country and cross-market linkages between Australian and US financial markets, evidence exists to suggest that cross-country spillovers within the market for the same asset are more pronounced than cross-market spillovers within the same country. Thus for the Australian bond market the most important influence is developments in the US bond market, followed by those in Australian share market. Similarly the Australian share market is more closely influenced by US share prices than by fluctuations in Australian bond yields.

Finally, volatility in Australian bond and share markets is found to exhibit marked asymmetries. For both markets, volatility is, on average, higher during bear markets than it is during bull markets. Also market falls are found to engender greater volatility than market rises of equal magnitude. Volatility is found to be more correlated both across countries and markets during periods of high volatility than in periods of low volatility, and in bear markets more than in bull markets.