1 Measuring Volatility Co-movement: An Empirical Investigation in North America, Europe and Asia Capital Markets. Mr. T.U.I Peiris Lecturer Department of Accountancy & Finance Sabaragamuwa University of Sri Lanka Belihuloya. 1 Dr. D.A.I Dayaratne Senior Lecturer Department of Accountancy & Finance Sabaragamuwa University of Sri Lanka Belihuloya. 2 Abstract The interdependence of global economy now extends across a far broader range of countries than ever before. An understanding of global volatility co-movement in between stock exchanges is important hence substantial changes in volatility of financial markets are capable of having significant negative effects on risk-averse investors. Thus, this study attempts to identify the co- movement of stock market volatility among the regions North America, Europe and Asia. The econometric models of Autoregressive Conditional Heteroskedasticity (ARCH), Generalized ARCH (GARCH), Johansen Cointegration Test, Vector Autoregression and VAR Variance Decompositions are employed. Daily returns of the market portfolio of these countries are used for the investigation. The period of study is 2000 to 2010 which represents current crisis movements of these markets. The empirical results indicate that the volatility co-movement is not that momentous since in all the markets more than 97% of the forecast error variance is explained by the market itself. However, the volatility co-movement between Sri Lanka stock market with that of India, Japan, Hong Kong, Singapore, UK and US stood in declining order of volatility co-movement respectively. Singapore and India are found to be the most endogenous markets with almost 03% of their forecast error variance is explained by the other markets under study. Key Words: ARCH, VAR and Volatility Co-movement. 1 Introduction In the contemporary finance research the stock market volatility has become major concern among investors and portfolio managers as it significantly influences for the portfolio management decisions. The encouragement underlying for the studies on volatility co-movement in world stock returns is to understand how joint movements in volatility influence the distribution of portfolio returns as this has implications for daily risk management, portfolio selection and derivative pricing. This is why finance theory suggests investors to hold assets that are not highly correlated among them. This suggests that equity markets have significant interrelationships between them as a result the benefits of international diversification reduced largely. Levy and Sarnat (1970) and Longin and Solnik (1974) report that existence of high correlations in stock returns between markets will not allow investors to reduce portfolio risk, holding expected return constant. The degree of correlation itself does not tell much about risk or volatility interactions of stocks. Moreover, the nature correlation between different assets are time varying. Therefore, explicit modeling of risk interactions of portfolios is highly recommended in finance research today. For example, Balasubramanyan (2004) reports that modeling of volatility co-movement demonstrates risk interactions and provides more accurate inputs to the classic portfolio formulation problem. 1 ushan@sab.ac.lk – corresponding author. 2 indunil@sab.ac.lk.