This paper examines the dynamic relationship between global factors and herding behavior in the oil-rich frontier stock markets of the Gulf Cooperation Council (GCC), using a time-varying transition probability Markov-switching model (TVTP-MS). Our results suggest that the GCC frontier stock markets respond significantly to the global market conditions in two distinct ways: (i) global fundamentals and market factors play a significant role in determining volatility regimes in these frontier markets as well as their transitions from one regime to another; and (ii) shocks in global systematic financial risks significantly contribute to investor herding in these frontier markets. Higher levels of global risk indexes including the VIX and the FSI as well as positive changes in the U.S. stock market performance and in the price of oil govern the transitions out of low into higher volatility states during which herding behavior is found to be present. Finally, we discuss policy and portfolio diversification implications.
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