Primary navigation:

QFINANCE Quick Links
QFINANCE Reference

Home > Capital Markets Best Practice > Interdependence of National and International Markets: The Foreign Information Transmission (FIT) Model

Capital Markets Best Practice

Interdependence of National and International Markets: The Foreign Information Transmission (FIT) Model

by Boulis Ibrahim and Janusz Brzeszczynski

Executive Summary

  • International financial markets transmit signals to each other through direct and indirect channels. Those processes can be analyzed for volatility of prices as well as for returns.

  • Transmission channels exist across different geographical regions and various asset classes.

  • The “meteor shower” effect is the transmission of signals across markets in different regions, usually in sequences in which they trade. The “heat wave” effect is the transmission of return or volatility signals within the same market over time.

  • Information about the existence of meteor showers and heat waves, such as their sign, strength, direction, stability, and statistical and economic significance, can lead to better and more profitable designs of investment strategies on stock, currency, and other financial markets.


The interdependence of national and international financial markets, both in returns and volatility, is well documented in the finance literature. Twenty-four-hour markets, such as the currency market, and less-continuous ones, such as stock markets, are known to exhibit correlation in returns and volatility both over time and across countries or regions. In many cases, such correlation has been increasing in recent decades. This apparent integration has been rationalized by increasing globalization, intensified international capital flows and investments, faster information transfer, harmonization of international regulations, increasing trade and market order flow, as well as enhanced alignment of economic scope, scale, and policy.

Engle, Ito, and Lin, in 1990, introduced the financial equivalent to the astronomical and meteorological phenomena of meteor showers and heat waves, as the interregional and region-specific persistence in volatility. The “meteor shower” (MS) effect refers to the transmission of information, as captured by volatility, across markets (when they trade in different regions and time zones). The “heat wave” (HW) effect is the transmission of information internally within the same market. The MS and HW effects are not mutually exclusive and, hence, during any period of time both of them can co-exist, even though one may dominate.

The MS persistence, or clustering, of volatility has been initially documented between only a few pairs of international stock markets, and for major foreign exchange rates in the currency market. Recently, however, evidence from the currency market has been extended, and innovative new methodology enabled wider and more thorough analyses of stock markets.

Interdependence in Currency Markets

There exists strong empirical evidence that information signals in the shape of volatility are transmitted, or “spill over,” in the currency market. Some studies have analyzed foreign exchange rates in five distinct regions of trading activity over the entire 24-hour day, namely: Asia, Asia–Europe overlap, Europe, Europe–America overlap, and America. Based on such time scales and geographical delineation, regional volatility models have been developed, in which volatility in one region is allowed to be a function of previous volatility in that region (“heat wave effect”), and volatility in other regions (“meteor shower effect”). The resulting evidence from empirical tests using historical data shows that in the currency market, the HW effect of own-region volatility spillover over time is usually statistically stronger, and more economically important than the MS effect across regions.1

Some of those studies use indicative trading quotes made by currency dealers, while others analyze unique proprietorship data of actual currency transactions reported by the main computer trading centers in London, Tokyo, and New York. They also investigate information linkages as measured by four variables beside volatility; namely, exchange rate return, direction of return, trading activity, and order flow.

In returns and return direction, there exist small informational linkages across trading regions, but not sufficiently significant to be of economic importance. Neither the HW nor the MS effects seem to explain much of the variation over time in the returns of major exchange rates.

These effects, however, seem to explain much more of the variation of volatility over time of these currency pairs. This statistical significance is also economically important, but the economic significance of the HW effect is much larger than that of the MS effect. As far as the smaller MS effect is concerned, it is much more pronounced between the trading region in which the shock originated and the next region in the chronological sequence of the 24-hour trading day, than between regions that are not chronologically sequential.

HW and MS also manage to explain some of the variation in trading activity, with economic significance having the same pattern as that of volatility. In order flow, which is often used as a proxy for information about economic fundamentals, HW and MS effects are detectable, too; however, economic significance can be attributed only to meteor showers.

Back to Table of contents

Further reading


  • Cai, F., E. Howorka, and J. Wongswan. “Informational linkages across trading regions: Evidence from foreign exchange markets.” Journal of International Money and Finance 27:5 (2008): 1215–1243.
  • Engle, R. F., T. Ito, and W.-L. Lin. “Meteor showers or heat waves? Heteroscedastic intra-daily volatility in the foreign exchange market.” Econometrica 59:8 (1990): 525–542.
  • Ibrahim, B. M., and J. Brzeszczynski. “Interregional and region-specific transmission of international stock market returns: The role of foreign information.” Journal of International Money and Finance 28:2 (2009): 322–343.
  • Ito, T., R. F. Engle, and W.-L. Lin. “Where does the meteor shower come from? The role of stochastic policy coordination.” Journal of International Economics 32:3–4 (1992): 221–240.
  • Melvin, M., and B. Peiers Melvin. “The global transmission of volatility in the foreign exchange market.” The Review of Economics and Statistics 85:3 (2003): 670–679.

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share