Nonlinear causality testing with stepwise multivariate filtering : evidence from stock and currency markets

Abstract

We examine the spillovers of the US subprime crisis to Asian and European economies and in particular to what extent currency and stock markets have been affected by the crisis. Linear and non-linear dependencies are detected after pairwise and system-wise causality analysis. A new stepwise multivariate filtering approach is implemented after controlling for conditional heteroskedasticity in the raw data and in VAR/VECM residuals using multivariate GARCH models. Significant nonlinear causal linkages persisted even after the application of GARCH-BEKK, CCC-GARCH and DCC-GARCH modelling. This indicates that volatility effects might partly induce nonlinear causality. Perhaps new short-term asset-pricing models could be developed to explain this stylized fact. These results might also have important implications for hedging, trading strategies and financial market regulation.