International financial transmission of shocks in stock, currency and money markets: evidence from structural VAR analysis

Abstract

Purpose How are financial shocks transmitted across borders and markets? We develop a system of structural equations that depicts the relation of stocks, exchange and interest rates, which provides a solution to simultaneity issues in financial markets. We apply the study to China vis-à-vis world economies over the period 2007 January–2025 September. Design/methodology/approach Structural vector autoregressive model is employed to test the system, based on which we analyse contemporaneous and dynamic relationships of financial markets and measure spillover effects of shocks by the approach of system-wide connectedness. Findings China is more interdependent with Asian and the USA than with European economies, but the interaction is asymmetrical: China's stock market has absorbed more risk than transmitted it out. Exchange rate shocks are a common risk source for stock markets. China is relatively not impacted by shocks in currency markets, reflecting its prudent policy controls. The financial stress in the global financial system is the fundamental driver that causes the stock spillover effects to China. Research limitations/implications Despite being less susceptible to exchange rate shocks, China has reciprocally become prone to international spillover effects of stocks and hence, exhibiting high stock volatility. The international co-movement of stocks is driven by the fear of investors of possible systemic risks in the global finance. Originality/value We propose a system of international financial transmission of shocks based on the literature. We associate the findings with the implications of macroeconomic conditions. We study the mechanisms how financial markets are connected and why stock markets co-move internationally.