The COVID-19 pandemic, declared in March 2020, caused a severe global financial market decline, impacting the global economy differently than previous crises like the Global Financial Crisis (GFC). Unlike the GFC, which was endogenous, COVID-19 was a purely exogenous shock. Existing research highlights return and volatility transmission mechanisms during the pandemic, focusing on spillover effects from news indices and investor sentiment on the travel and leisure (T&L) sector. Studies have shown significant spillovers from news indices (panic, media hype, contagion) to T&L stocks, and from investor mood indices to the tourism sector. While these studies provide valuable insights into the T&L sector's vulnerability, they largely neglect the interlinkages between T&L and other sectors and their implications for portfolio design during the pandemic. One study examined the return and volatility transmission between tourism and healthcare sectors in the US, finding negative bidirectional return spillovers and the potential for healthcare to act as a hedge. This study aims to address this gap by investigating the dynamic linkages among service sectors (T&L, healthcare, technology, and telecommunications) and their implications for portfolio design across various geographical regions. This will contribute to the understanding of COVID-19-induced inter-sector risk and return spillovers and their implications in four key areas: 1) extending the analysis to include technology and telecommunications sectors; 2) broadening the regional scope to include Europe, Eastern Europe, and Asia-Pacific; 3) utilizing the Diebold and Yılmaz (2014) approach to analyze spillover direction; and 4) providing operational findings for fund managers, including optimal portfolio weights and hedge ratios.

Several studies have examined the impact of the COVID-19 pandemic on various sectors, revealing heterogeneous effects. Some research focuses on the spillover effects from news/media-related indices on T&L stock returns and volatilities, identifying contagion channels from news indices and global T&L stocks to regional T&L stocks. Other studies investigate spillovers from investor mood, fear, sentiment, and policy uncertainty indices to the tourism sector and the connectedness among T&L stocks across different countries. The impact of COVID-induced news indices (panic, fake news) on T&L stock connectedness has also been examined, revealing strong volatility spillovers. Furthermore, research has explored downside risk spillovers among listed tourism firms, showing an increased risk contagion during the pandemic. However, limited attention has been given to the linkages between T&L and other sectors and their implications for portfolio design. One study analyzed the intersectoral relationship between tourism and healthcare in the US, but further research is needed to include additional sectors and geographical regions.

This study uses daily data for four service sectors (T&L, healthcare, technology, and telecommunications) from Europe, Eastern Europe, Asia-Pacific, and North America, spanning from January 1, 2013, to November 12, 2021. Daily continuously compounded returns are calculated. The Diebold and Yılmaz (2014) approach is employed to analyze return and volatility spillovers using a generalized VAR model. The total, directional, and net directional spillover effects are measured based on forecast error variance decomposition. The dynamic conditional correlation (DCC)-GARCH model (Engle, 2002) is used to investigate time-varying conditional correlations between sector returns. Optimal portfolio weights and risk-minimizing hedge ratios are calculated based on the DCC-GARCH results. The Kroner and Ng (1998) approach is used for optimal portfolio weights, and the Kroner and Sultan (1993) approach is employed for calculating hedge ratios. The hedging effectiveness index (HEI) (Ederington, 1979) is calculated to determine the success of hedging strategies, comparing HEI values during and before the COVID-19 outbreak. A 200-day rolling window is used to estimate time-varying system-wide connectedness.

The study found substantial return and volatility spillovers among the four sectors during the entire sample period. Analysis of pre- and during-COVID-19 periods revealed that the pandemic significantly impacted both positively and negatively affected sectors, shifting them to a more volatile regime with intensified spillover effects. Volatility spillovers were higher during the pandemic across all sectors, indicating widespread uncertainty. The largest system-wide return connectedness was observed in North America (61.71%), while Eastern Europe had the lowest (42.08%). In terms of directional return spillovers, Europe's technology sector was the largest contributor to other sectors' returns, while T&L was the smallest contributor. Regarding volatility spillovers, the technology and healthcare sectors emerged as net transmitters across all regions, while T&L remained a net receiver. Dynamic analysis using a rolling window confirmed time-varying return and volatility spillovers, peaking during the pandemic. Net pairwise directional spillover analysis showed that T&L was primarily a net receiver of return and volatility spillovers during the pandemic. Dynamic conditional correlation analysis corroborated the DY analysis, showing increased correlations between T&L and the other three sectors during the pandemic, although the increase was short-lived. Portfolio analysis showed that optimal portfolio weights for healthcare, telecommunications, and technology increased during the pandemic, suggesting investors should increase their holdings in these sectors to reduce risk and protect returns. Hedge ratios varied between the pre- and during-pandemic periods, indicating the need for adaptable hedging strategies. The study also measured the hedging effectiveness, with technology stocks offering the highest risk reduction in Europe and North America.

The findings highlight the significant impact of the COVID-19 pandemic on intersectoral linkages and their implications for portfolio management. The increased return and volatility spillovers during the pandemic underscore the importance of considering inter-sector dynamics in investment decisions. The results support the inclusion of healthcare, technology, and telecommunications sectors in portfolios to mitigate risk, particularly during crises. The varying hedge ratios and portfolio weights emphasize the need for dynamic hedging and portfolio rebalancing strategies based on changing market conditions. The findings extend previous research by including a wider range of sectors and regions, providing a more comprehensive understanding of the intersectoral relationships during a global pandemic.

This study provides valuable empirical evidence on the dynamic return and volatility spillovers between positively and negatively affected service sectors during the COVID-19 pandemic. It underscores the importance of considering intersectoral linkages for portfolio diversification and hedging. Investors should strategically adjust their portfolio weights and hedging strategies to account for the increased connectedness and volatility during crises. Future research could explore the impact of other significant events (like the Russia-Ukraine war) and explore other connectedness approaches.

The study focuses solely on the COVID-19 pandemic, limiting the generalizability of findings to other types of crises. The use of specific sector indices might not fully capture the heterogeneity within each sector. Future research could explore alternative methodologies and broader sector classifications.