Abstract:
This study examines return spillovers among Sri Lanka’s equity market (ASPI), the
LKR/USD exchange rate, gold futures, and crude oil futures using a time-varying
parameter VAR connectedness framework with daily data for 2005-2024.
Generalised forecast error variance decompositions provide time-varying total,
directional, net, and pairwise measures. Results show that the mean Total
Connectedness Index (TCI) is 9.99%, and own variance shares range from 87.32% to
92.57%, indicating that own shocks dominate on average while cross-market
transmission is present. The TCI series shows pronounced time variation. In most
periods, the TCI remains in the 5-15% range. Two major surges are visible. The first
occurs in early 2020, when the TCI rises above 60-70% and then declines. The second
occurs in 2022, coinciding with domestic currency and funding stress, with values
above 40-50% for a limited interval. Between these episodes the TCI reverts toward
lower levels, indicating reduced cross-market propagation. Average directional
transmission indicates that commodities are the primary sources of spillovers. Crude
oil transmits 12.83% of shocks to the system, and gold transmits 12.30%. ASPI and
USD/LKR transmit 7.47% and 7.35%, respectively. Net positions at the sample mean
are near zero: 0.15 for crude oil, 0.01 for gold, -0.08 for ASPI, and -0.07 for
USD/LKR. These values imply mild average transmitter-receiver roles when
aggregated, with roles changing during the high-TCI episodes. Pairwise contributions
are consistent with these patterns. Shocks from crude oil explain 8.19% of gold’s
variance, and shocks from gold explain 7.97% of crude oil’s variance. Cross-effects
between domestic equity and the exchange rate are smaller: USD/LKR accounts for
3.05% of ASPI’s variance and ASPI accounts for 2.97% of USD/LKR’s variance.
The evidence indicates time-varying integration between global commodities and Sri
Lankan financial variables at the daily frequency, with commodities exerting greater
influence than domestic markets on average. The TCI path dates episodes of elevated
connectedness and can support portfolio allocation, currency and commodity
hedging, and market surveillance. Future work can examine determinants of TCI
peaks, assess robustness and discount factors within the TVP-VAR framework.
