Page 19 - 2022 Abstract Book RUICHSS_2022_11_17 after conference

University of Ruhuna ISSN: 2706-0063
Matara, Sri Lanka

are especially severe in Sri Lanka and other developing economies because of the
severe economic downturn and poor economic recovery from the COVID-19 crisis.

The above scenarios suggest that Sri Lanka will not be immune to spillovers
from global markets, especially the pressure from rising commodity prices globally.
In this environment, understanding the risks to the economy is more important than
ever. This presentation will focus on three economic sectors impacted by the COVID-
19 pandemic; (1) commodity prices, (2) financial sector, and (3) currency market to
assess the risk spillover and connectedness among assets for the pre-COVID and
COVID periods.
The vast literature suggests that the interconnectedness of risks between
commodity, currency, and equity markets has strengthened over time. Broadly,
interconnectedness refers to the degree of interactions between financial institutions,
markets, or economies. According to conventional wisdom, the highly interconnected
structure of banking systems or markets is caused by globalization. Cecchetti (2012)
argues that financial globalization benefits the economy up to a point and that high
levels of integration could weaken the financial system. COVID-19, apart from being
a health crisis, has also created uncertainties in various sectors of the economy, with
an increase in market volatilities as the economies become much closer during the
crisis. When countries are more connected, the spillovers from one economy to
another or market to another may transmit systemically. Systemically transmitted risk
can be broadly defined as the likelihood that an event at the institutional level could
trigger severe instability or collapse of an entire sector or economy.

To further explore the mechanism of the transmission and repercussions of
the connectedness, firstly, I present the finding on the intensity of risk spillover for
the commodity market in detail. From the regulatory perspective, analyzing the role
of dependencies among financial markets could help policymakers understand the
risk exposure that distress the economy. Secondly, the findings on the strength of the
interconnectedness in the financial sector, which measure the roles of direct and
indirect dependencies, are presented.

The connectedness of financial and economic variables has increasingly
become more critical for financial market participants and policymakers alike,
especially after the global financial crisis (GFC). An in-depth understanding of the
connectedness of the commodity market is vital in determining Sri Lanka's
international financial risk level.

xviii