Modelling Spillover Effects of Oil Shocks on Emerging Markets: Copula based CoVaR Approach

Abstract

This paper investigates the co-movements of oil market and emerging stock markets using copula models. Our sample covers six emerging stock markets, namely, South Korea, Taiwan, Mexico, China, Brazil and Turkey and data from Brent oil prices. We employ symmetric and asymmetric copula structures and determine the best fitting copula through goodness-of-fit testing procedure. Proceeding the parameter estimations, we also analyse the probability of portfolio risk via VaR models. The findings indicate lower tail dependence for Brent-Taiwan pair, whereas the other market associations are characterized by symmetric heavy tails. VaR models also imply that Brent-Brazil and Brent-China are the riskiest of all portfolios that we have considered. Moreover, this paper measures the spillover effects of a shock on Brent oil market on the emerging stock market using CoVaR analysis. Findings of CoVaR models imply that Chinese, Brazilian and Turkish stock markets face with the largest losses following an extreme movement in the Brent oil market. The results provide valuable information for investors who plan to consider oil as an important asset while establishing portfolio composed of emerging market stocks.