Risk spillover effects between financial markets

Abstract

Due to capital flow liberalization, financial instruments react swiftly to market information. Utilizing the structural vector autoregression (SVAR) approach, this study analyzes risk spillover effects between financial markets in South Africa and Nigeria. Findings indicate significant risk spillovers between stock and exchange rate markets in both countries. In Nigeria, extraordinarily high exchange rate volatility acts as a major destabilizing variable, contributing significantly to stock market instability and showing high sensitivity to the United States interest rate spread. Conversely, South African stock returns exhibit high shock volatility, but remarkably stable interest rates indicate effective central bank regulation for shock absorption, though exchange rates react strongly to stock return shifts. Crucially, South African markets mean-revert within a week, whereas Nigerian markets exhibit long-memory responses, creating disequilibrium for up to a month with delayed stock return impacts from currency swings. Ultimately, this structural market heterogeneity underscores the critical need for enhanced risk management practices and international financial cooperation.