Transmission Channels of Financial Shocks to Stock, Bond, and Asset-backed Markets ― An Empirical Model

Researchers, policymakers and commentators have long debated the patterns through which adverse shocks in a few markets may quickly spread to a range of apparently disconnected financial markets causing widespread losses and turmoil.

This book uses modern linear and nonlinear econometric methods to characterize how shocks to the yield of risky fixed income securities, such as sub-prime asset-backed or low-credit rating sovereign bonds, are transmitted to the yields in other markets. These include equity and corporate bond markets as well as relatively risk-free fixed income securities, such as highly rated asset-backed securities and sovereign bonds from core Eurozone countries. The authors analyse and compare the results from linear and nonlinear models to identify and assess four distinct contagion channels characterizing both US and European financial markets. These include the correlated information, the risk premium, the flight-to-liquidity, and the flight-to quality channels. The results of this study support the theory that both investors and policy-makers ought to pay special attention to liquidity and commonalities in the perceptions of the probabilities of default, as channels through financial shocks propagate.

Viola Fabbrini is a researcher at Bocconi University, Italy, and has experience as an analyst in mergers and acquisition advisory in the US.

Massimo Guidolin is Professor of Finance at Bocconi University and Director of Bocconi's FT-ranked MSc in Finance, where he teaches courses in financial econometrics and asset pricing at a graduate level. He serves on the editorial board of a number of journals, such as the Journal of Banking and Finance, the Journal of Economic Dynamics and Control, and the International Journal of Forecasting. His research has been published in outlets such as the American Economic Review, the Journal of Financial Economics, the Review of Financial Studies, and the Journal of Econometrics.

Manuela Pedio is a researcher at Bocconi University and has experience as an analyst in derivatives sales and trading. She teaches courses in portfolio management and introductory statistics at Bocconi. She has had several grants to support her research in financial econometrics and fixed income and derivatives pricing. She is the winner of the 2014 UniCredit European Award for the Best Research Paper.