Asymmetric connectedness of stocks: How does bad and good volatility spill over the U.S. stock market?

TL;DR

This paper investigates how good and bad volatility spill over among U.S. stocks, revealing asymmetric transmission patterns that vary across sectors and over time, especially during periods of increased market uncertainty.

Contribution

It introduces a method to quantify asymmetries in volatility spillovers and provides empirical evidence of their sector-specific and temporal variations in the U.S. stock market.

Findings

Bad and good volatility spill over at different magnitudes across sectors.

Asymmetries in volatility transmission change over time.

Market uncertainty increases overall connectedness during crises.

Abstract

Asymmetries in volatility spillovers are highly relevant to risk valuation and portfolio diversification strategies in financial markets. Yet, the large literature studying information transmission mechanisms ignores the fact that bad and good volatility may spill over at different magnitudes. This paper fills this gap with two contributions. One, we suggest how to quantify asymmetries in volatility spillovers due to bad and good volatility. Two, using high frequency data covering most liquid U.S. stocks in seven sectors, we provide ample evidence of the asymmetric connectedness of stocks. We universally reject the hypothesis of symmetric connectedness at the disaggregate level but in contrast, we document the symmetric transmission of information in an aggregated portfolio. We show that bad and good volatility is transmitted at different magnitudes in different sectors, and the asymmetries sizably change over time. While negative spillovers are often of substantial magnitudes, they do not strictly dominate positive spillovers. We find that the overall intra-market connectedness of U.S. stocks increased substantially with the increased uncertainty of stock market participants during the financial crisis.