Time-Frequency Connectedness between Digital Financial Development and Traditional Financial Markets - Evidence from the Development of Digital Finance in China

This study is the first attempt to construct return and volatility spillover indices and form a risk spillover network in a generalized forecast error variance decomposition framework to measure the time-frequency domain connectedness between digital financial development and traditional financial markets (stock, gold, bond, and foreign exchange markets). The results indicate that there is a weak integration relationship between digital financial development and traditional financial markets, and the volatility connectedness is stronger than the return connectedness. The return spillover between the two is mainly contributed by the short-term spillover effects, while the volatility spillover is the opposite. Digital financial development acts as a short-term spillover receiver and long-term spillover transmitter for traditional financial markets. Moreover, the connectedness between digital financial development and traditional financial markets is time-varying. During uncertain times such as the Sino-US trade war and the COVID-19, digital financial development is mainly influenced by fluctuations in the traditional financial markets. In the period of digital financial development, digital financial development can serve as a return spillover receiver of the traditional financial market, which is beneficial to the stable development of the traditional financial market. This study has important implications for investors to select hedging instruments, hedge risk spillover portfolios, and regulate digital financial development and traditional financial markets.