Time-Frequency connectedness between developing countries in the COVID-19 pandemic: The case of East Africa

Abstract

Models of crisis prediction continue to gain traction with the increased frequency of global crisis such as the ongoing COVID-19 pandemic. Moreover, the connectedness of financial markets appears to be of central importance in determining how shocks spill through asset market linkages. The study thus applies the time-frequency connectedness measures of Diebold & Yilmaz (2012) and Baruník & Křehlík (2018) to examine return and volatility connectedness dynamics in East African Community (EAC) member states. The study found a strong interdependence among the considered EAC markets as indicated by the high values of total return and volatility spillover indices. This high degree of interdependence is reflected in both static time and frequency domain return and volatility connectedness, especially at the longer term frequency bands, an indication that return and volatility shocks are persistent. This result lends further support to existing evidence on the suitability of the EAC regional economic integration, including the possible eventual establishment of a monetary union. In addition, the dynamic spillover analysis indicates that connectedness among these EAC markets is highly time-varying and appears to be amplified during global crisis events such as the European debt crisis, Kenyan elections, commodity price shocks and the COVID-19 pandemic. However, the results suggest that relative to periods of domestic turbulence, financial market connectedness in the EAC is more likely to get amplified during periods of external global shocks. The study also contributes to emergent literature on connectedness among financial markets during the COVID-19 pandemic. Importantly, the study finds that the COVID-19 pandemic had a significant effect on all the considered EAC markets although the magnitude and direction of impact varies across markets and countries. In addition, the study finds that Brent Crude oil prices are a significant source of return and volatility spillovers to EAC markets especially during crisis periods.