TY - JOUR
T1 - How do normalization schemes affect net spillovers? A replication of the Diebold and Yilmaz (2012) study
AU - Caloia, Francesco Giuseppe
AU - Cipollini, Andrea
AU - Muzzioli, Silvia
PY - 2019/10
Y1 - 2019/10
N2 - This paper replicates the Diebold and Yilmaz (2012) study on the connectedness of the commodity market and three other financial markets: the stock market, the bond market, and the FX market, based on the Generalized Forecast Error Variance Decomposition, GEFVD. We show that the net spillover indices (of directional connectedness), used to assess the net contribution of one market to overall risk in the system, are sensitive to the normalization scheme applied to the GEFVD. We show that, considering data generating processes characterized by different degrees of persistence and covariance, a scalar-based normalization of the Generalized Forecast Error Variance Decomposition is preferable to the row normalization suggested by Diebold and Yilmaz since it yields net spillovers free of sign and ranking errors.
AB - This paper replicates the Diebold and Yilmaz (2012) study on the connectedness of the commodity market and three other financial markets: the stock market, the bond market, and the FX market, based on the Generalized Forecast Error Variance Decomposition, GEFVD. We show that the net spillover indices (of directional connectedness), used to assess the net contribution of one market to overall risk in the system, are sensitive to the normalization scheme applied to the GEFVD. We show that, considering data generating processes characterized by different degrees of persistence and covariance, a scalar-based normalization of the Generalized Forecast Error Variance Decomposition is preferable to the row normalization suggested by Diebold and Yilmaz since it yields net spillovers free of sign and ranking errors.
KW - Causality
KW - Generalized forecast error variance decomposition
KW - Normalization schemes
KW - Simulation
KW - Spillover
KW - Vector autoregression models
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U2 - 10.1016/j.eneco.2019.104536
DO - 10.1016/j.eneco.2019.104536
M3 - Article
AN - SCOPUS:85074614893
VL - 84
SP - 1
EP - 13
JO - Energy Economics
JF - Energy Economics
SN - 0140-9883
M1 - 104536
ER -