Measuring the Frequency Dynamics of Financial Connectedness and Systemic Risk*

TLDR

High‑frequency connectedness signals rapid, short‑term market reactions, while low‑frequency connectedness indicates persistent, long‑term shock transmission. The authors propose a framework to measure frequency‑dependent financial connectedness arising from heterogeneous shock responses. The framework estimates connectedness across short, medium, and long cycles via a spectral representation of variance decompositions. Empirically, the method reveals rich time‑frequency dynamics of volatility connectedness among U.S.

Abstract

We propose a new framework for measuring connectedness among financial variables that arise due to heterogeneous frequency responses to shocks. To estimate connectedness in short-, medium-, and long-term financial cycles, we introduce a framework based on the spectral representation of variance decompositions. In an empirical application, we document the rich time-frequency dynamics of volatility connectedness in U.S. financial institutions. Economically, periods in which connectedness is created at high frequencies are periods when stock markets seem to process information rapidly and calmly, and a shock to one asset in the system will have an impact mainly in the short term. When the connectedness is created at lower frequencies, it suggests that shocks are persistent and are being transmitted for longer periods.