Risk spillovers in international equity portfolios

Matteo Bonato, Massimiliano Caporin and Angelo Ranaldo



JEL classification
C13, C16, C22, C51, C53, G17

Risk spillover, portfolio risk, currency risk, variance forecasting, international portfolio, Wishart distribution


We define risk spillover as the dependence of a given asset variance on the past covariances and variances of other assets. Building on this idea, we propose the use of a highly flexible and tractable model to forecast the volatility of an international equity portfolio.

According to the risk management strategy proposed, portfolio risk is seen as a specific combination of daily realized variances and covariances extracted froma high frequency dataset, which includes equities and currencies. In this framework, we focus on the risk spillovers across equities within the same sector (sector spillover), and fromcurrencies to international equities (currency spillover). We compare these specific risk spillovers to a more general framework (full spillover) whereby we allow for lagged dependence across all variances and covariances. The forecasting analysis shows that considering only sector- and currency-risk spillovers, rather than full spillovers, improves performance, both in economic and statistical terms.