Regime-Dependent Volatility Spillovers: Extrication of the Effect of Geopolitical Risk of China on South Asian Equity Markets

Abstract

The study explores the regime-dependent volatility spillover and clustering from the geopolitical risk of China to the equity markets of South Asia by employing the econometric models of Markov-Switching GARCH and DCC-GARCH. The findings have shown that the impact of geopolitical risk is different across different regimes. It has negatively affected the stock markets of India (NIFTY-50) and Nepal (NEPSE) during the low-volatility regimes. Moreover, its impact is more negative and significant on the stock exchange of Pakistan (KSE) during the regime of high volatility. The finding confirms the persistence of volatility in the long run; however, the volatility spillover in the short run is not significant. Moreover, the study has found positive and weak correlations among the geopolitical risk of South Asian equity markets except for Nepal, which has having negative correlation with it. It suggests the benefits of diversification for international portfolio managers and investors as well. Overall, the findings provide insights for portfolio managers, investors, and policymakers by emphasising the importance of geopolitical risk while administering risk management and hedging strategies for mitigating its effects in today's globalised financial markets.

Keywords: Geopolitical Risk, Volatility Spillover, Markov-Switching GARCH, DCC GARCH