The Dynamic Spillover Effect of Cross-Market Financial Risk in China: Systematic Risk and Idiosyncratic Risk

The purpose of this paper is to reveal the characteristics, roles and sizes of the risk types (systematic risk and idiosyncratic risk) of different financial markets in cross-market contagion in China. Therefore, this paper first constructs the financial stress index (FSI) of the banking sector, the stock market, the bond market and the exchange rate market. Secondly, principal component analysis (PCA) is used to decompose the financial stress index of four financial markets into the systematic risk and the idiosyncratic risk. Finally, we use the generalized variance decomposition method of Diebold and Yilmaz (2012) to study the dynamic spillover effect among the systematic risk and the idiosyncratic risk of the four financial markets. The innovative findings of this paper are as follows: (1) If the interaction and strong contagion of the systematic risk and the idiosyncratic risk are not taken into account, the degree of cross-market risk contagion is seriously underestimated. (2) Although the systematic risk contagion network and the idiosyncratic risk contagion network of the four markets are relatively “self-contained”, we can still identify that bank systematic risk plays an important role in connecting the two networks and is an important connecting node in the whole system. (3) In the systematic risk network, there are significant two-way spillovers between the bond market and the bank, between the stock market and the bond market, and between the stock market the foreign exchange market, which are the most important “connecting lines” in the systematic risk spillover network. The systematic risk of the bond market is a significant net sender of risk and the systematic risk of the bank is a significant net receiver of risk. (4) Compared with the systematic risk network, the contagion network relationship between the idiosyncratic risks of the four markets is much closer, in which the idiosyncratic risk of the bond market is the significant net risk sender, while the idiosyncratic risk of the exchange market is the net risk receiver. (5) In the face of various financial shocks, such as the subprime mortgage and European debt crisis, the liquidity crisis in 2013, the stock market crash and the “811” exchange rate reform in 2015, the high risk of shadow banking in 2017, and the outbreak of Sino-US trade frictions in 2018, risk spillovers and contagion have increased, and different markets (and different types of risks play a “systemically important financial market (SIFMs)” role in the face of different financial shocks. (6) Compared with financial shocks, major public health shocks (such as COVID-19) are more significant, and the spillover network relationship between financial markets presents a more complex and intertwined network structure, and the idiosyncratic risk of each market plays an important spillover role. Therefore, it is very important to distinguish different risk types, judging the important connecting lines in the risk spillover network, and identifying the SIFMs in different periods for crisis prevention and crisis management.