Fundamentals,beliefs, and financial contagion

We study contagion in a model in which financial crises can occur due to both weak fundamentals and adverse self-fulfilling expectations. Contagion emerges only if a crisis in one country leads international investors to rationally update beliefs about fundamentals in other countries. But purely expectational crises may be contagious, as investors may infer that fundamentals are weak. Hence, the structure of information is crucial. The analysis delivers useful lessons for assessing which countries are more vulnerable to contagion, which types of crises are more infectious, and whether increased transparency ameliorates contagion effects.     

Eurozone crisis and BRIICKS stock markets: Contagion or market interdependence?

This paper examines the financial contagion in an emerging market setting by investigating the contagion effects of GIPSI (Greece, Ireland, Portugal, Spain and Italy), USA, UK and Japan markets on BRIICKS (Brazil, Russia, India, Indonesia, China, South Korea and South Africa) stock markets. During Euro-zone crisis period (October 19, 2009–January 31, 2012), the empirical results indicate that among GIPSI countries, Ireland, Italy and Spain appear to be most contagious for BRIICKS markets compared to Greece. The study reports that Brazil, India, Russia, China and South Africa are strongly hit by the contagion shock during the Eurozone crisis period. However, Indonesia and South Korea report only interdependence and not contagion. From policy perspective, the findings provide useful implications for possible decoupling strategies to insulate the economy from contagious effects. For multilateral organizations like International Monetary Fund (IMF) and World Bank, the study will provide an important direction in undertaking coordinated rescue measures for the vulnerable as well as contagious countries.     

Translating financial integration into correlation risk: A weekly reporting's viewpoint for the volatility behavior of stock markets

We apply the multivariate extension of GARCH-type models in order to assess the systematic and systemic risks as well as the joint volatility behaviors of the U.S. and three European financial markets (Andersen et al., 2010). Therefore, we can appraise the co-movements of the four previous financial markets as well as the joint behavior of their respective volatilities (i.e. systemic risk). Moreover, the resulting conditional variance and covariance metrics allow for handling volatility spillovers (i.e. contagion risk in terms of transmitting volatility shocks from one market place to another market place). Indeed, results highlight the unprecedented high systemic risk levels (i.e. joint increased volatility levels) as well as a high contagion risk (i.e. volatility spillover) during the subprime mortgage market crisis. The transmission process of volatility shocks reveals to be simultaneous across financial markets due to a strong arbitrage activity and electronic trading practices among others. Most importantly, the estimated conditional correlations exhibit an upward sloping trend, which underlines an increase in the correlation risk between financial markets in the late nineties or early 2000. Thus, our major findings are twofold. First, we characterize the dynamic correlation risk across financial markets. Second, we also confirm the increasing and nonlinear trend in the correlation risk, which we are able to quantify.     

The source of global stock market risk: A viewpoint of economic policy uncertainty

This study explores the effect of economic policy uncertainty (EPU) in four countries or regions (China, Japan, Europe, and the United States) on the contagion risk of investments in the global stock market. The stock returns of 22 stock markets worldwide are analyzed to determine which region’s EPU exhibits the greatest effect on regional systematic risk in the global stock market and on volatility risk in individual stock markets. First, all of the samples, the markets of different continents and the spillover indices of the developed and emerging markets, are calculated to observe the dynamic correlation among these markets with the aim of quantifying regional systematic risk and further examining the contagion risk effect of EPU. The results indicate the following: EPU in China is the most influential, and its contagion risk spreads to different regional markets, except for Europe; the effect of EPU in the United States is inferior to that in China; EPU in Japan merely influences contagion risk in emerging markets; contagion risk in European markets is not influenced by the four EPU indices; and EPU in Europe is not influenced by contagion risk in the global stock market. However, according to the volatility risk in each market, the EPU in Europe and China respectively influence Asian countries and European countries the most. These results may be attributable to the extremely high trade dependence among these countries because the performance of international enterprises is mainly determined by the economic policies of their trading partners.     

Regime dependent volatilities and correlation in international securitized real estate markets

This paper studies the role of regime shifts and time-varying volatilities in market integration in a Markov-switching volatility regime environment among the US, European and Asian developed securitized real estate markets. With a two-state volatility model, the study finds the co-dependence, co-movement and synchronization of volatility regime at the high volatility state are stronger between the US and European securitized real estate markets. Although correlations among the markets are higher in a high volatility regime than in a low volatility regime, there is limited evidence of contagious effects during the high volatility periods between some markets. Moreover, the unsecuritized real estate markets are different from their securitized equivalent in the volatility regime characteristics, correlation pattern and level, as well as the extent of correlation change and contagion effect in high volatility state. Thus, the regime-switching results from stock markets may not be automatically extended to the corresponding public real estate markets, and requires rigorous empirical scrutiny.     

Time-varying dependence in European equity markets: A contagion and investor sentiment driven analysis

In the light of the global financial crisis and sovereign debt crisis, this paper investigates the dependence patterns in 24 European equity markets from January 5, 2004 to July 1, 2016. We further examine whether these stressful events trigger contagion. Given that investors tend to behave irrationally in turmoil periods, we add to the literature by studying the effect of investor sentiment on markets correlations. Our results reveal heterogeneity in the time-varying dependence and across markets. Contagion is confirmed in turbulent times, a spillover effect from periphery euro area being detected. We find that similar sentiments increase correlations, especially in crises, suggesting that investors’ perceptions are an important channel of moving markets in the same direction. Furthermore, negative sentiments, such as fear or pessimism, amplify the linkages between markets. Our results offer useful insights to policy makers for reacting timely to financial shocks and for designing a more integrated market.     

What can wavelets unveil about the vulnerabilities of monetary integration? A tale of Eurozone stock markets

The study has two main objectives: (i) to investigate whether there is pure contagion or fundamental-based contagion/interdependence among the Eurozone equity markets (Germany, France, Italy, Spain and Netherlands), attributable to the shocks stemming from nine major crises around the world (ii) to investigate the evolution of market integration, whether mainly short-run or long-run. Wavelet decompositions, in both its discrete and continuous forms, are employed to unveil the multi-horizon nature of co-movements, volatility and lead–lag relationships. This is to unveil the path of linkages and the behavior underlying the transmission mechanism of financial shocks across major Eurozone stock markets. Evidence also supports the presence of common shocks whereby equity markets in Eurozone are significantly affected by episodic crisis events globally. Prior to the recent subprime crisis, contagion effects have generated short-term shocks that may potentially involve, among other factors, excessive channels. In stark contrast, the most recent US subprime crisis and EMU sovereign debt crisis reveal the evidence of fundamental-based contagion. We also find the increasing short-run and long-run stock market integration, driven by several stages of the establishment of EMU. Policy implications for regulators and investors are discussed in the context of continued monetary integration.     

How globally contagious was the recent US real estate market crisis? Evidence based on a new contagion test

This paper utilizes a new contagion test based on case-resampling bootstrap technique to investigate whether there is any contagion effect in the interaction of the US real estate market with those of Australia, Japan and the UK arising out of the recent US real estate crisis or subprime crisis. Contrary to expectations, it is found that the relationship of the US market with the other markets following the US real estate market crisis cannot be characterized as one with contagion effect. Its relationship with the other markets is rather characterized by dependency behavior that prevails regardless whether the markets are under distress or not.     

Evidence for Financial Contagion in Endogenous Volatile Periods

The objective of this study is to analyze cross‐border contagious dynamics in both foreign exchange markets and stock exchange markets. Propagation is analyzed with respect to the transmission of excessive volatility that is endogenously determined. The contagion process is discussed in the context of financial systems, foreign direct investments and trade. Implementing a vector autoregressive‐multivariate generalized autoregressive conditional heteroskedasticity (VAR‐MGARCH) model, we show that country‐specific turbulence in financial markets is able to create unanticipated financial contagion across countries. Diversified trade and financial relations decrease the risk of exposure to contagion from external markets. The world's largest economies, however, play a price‐setter role, and diversification is of secondary importance. Asymmetric transmission of the empirically predicted contagion prevails in the latter case.     

Financial contagion and volatility spillover: An exploration into Indian commodity derivative market

This study measures the extent of financial contagion in the Indian asset markets. In specific it shows the contagion in Indian commodity derivative market vis-à-vis bond, foreign exchange, gold, and stock markets. Subsequently, directional volatility spillover among these asset markets, have been examined. Applying DCC-MGARCH method on daily return of commodity future price index and other asset markets for the period 2006–16, time varying correlation between commodity and other assets are estimated. The degree of financial contagion in commodity derivative market is found to be the largest with stock market and least with the gold market. A generalized VAR based volatility spillover estimation shows that commodity and stock markets are net transmitters of volatility while bond, foreign exchange and gold markets are the net receivers of volatility. Volatility is transmitted to commodity market only from the stock market. Such volatility spillover is found to have time varying nature, showing higher volatility spillover during the Global Financial Crisis and during the period of large rupee depreciation in 2013–14. These results have significant implication for optimal portfolio choice.     

Which way does water flow? An econometric analysis of the global price integration of water stocks

Around US$600 billion of investment is desperately needed to address forecasted huge shortages in water supply globally. A number of worldwide investors – so-called water funds – have started to take up this challenge. For these global water investors, knowledge about the extent of integration between the water sectors of financial markets is highly important. According to international portfolio diversification theory, the less (more) integrated markets are, the more (less) benefits there are from international diversification. In this study, we investigate the extent and manner of interdependence among the US, European and Asian water sector of the equity markets based on Vector Autoregression (VAR), Granger causality and impulse response analyses. We find that world water stock market prices are indeed significantly interdependent although this interdependence varies across time periods. Each market quickly responds to shocks from each other and completes its response within 3 days. Hence, for water investors, international diversification that is undertaken just within the water sector will not be beneficial. The result also implies that there is the risk of crossmarket contagion – that is, price volatility spill over across water sectors of different financial markets, and therefore, water authorities in one market should take cognisance of events in other markets.     

Bull or bear markets: A wavelet dynamic correlation perspective

In this paper, we contribute to the literature on the international stock market co-movements and contagion, especially during the recent subprime crisis, by researching the interconnections between international stock markets in time-frequency domain.Our innovative approach consists on carrying out a wavelet decomposition of return time series before investigating the correlation dynamics across stock markets during the recent financial crisis. It thus enables us to show how the contagion dynamics between international stock market returns are changing across time scales corresponding to investors with heterogeneous time horizons. Moreover, our results reveal that the contagion dynamics depends on the bull or bear periods of stock markets, on stock markets maturity, and on regional aspects. Therefore, all these finding should be considered from an international portfolio diversification perspective.     

Inducing liquidity in thin financial markets through combined-value trading mechanisms

Asset pricing theory hypothesizes that investors are only interested in portfolios; individual securities are evaluated only in terms of their contribution to portfolio risk and return. Yet, standard financial market design is that of parallel, unconnected markets, whereby investors cannot submit orders in one market conditional on events in others. When markets are thin, this exposes them to substantial execution risk. Fear of ending up with unbalanced portfolios after trading may even keep investors from submitting orders, further eroding liquidity and the ability of markets to equilibrate. The suggested solution is a portfolio trading mechanism referred to as combined-value trading (CVT). Investors are allowed to submit orders for packages of securities and the system matches trades and computes prices by optimally combining portfolio orders in an open book. We study the performance of the CVT mechanism experimentally and compare it to the performance of parallel, unconnected double auctions in experiments with similar parametrization and either a similar number of subjects or substantially thicker markets. We present evidence that our portfolio trading mechanism facilitates equilibration to the extent that the thicker markets do. Inspection of order submission and trade activity reveals that subjects manage to exploit the direct linkages between markets enabled by the CVT system.     

Has co-movement dynamics in emerging stock markets changed after global financial crisis? New evidence from wavelet analysis

In this article, we revisit the issue of contagion, interdependence and changes in correlation structure after the Global Financial Crisis (GFC) of 2008 between developed and emerging markets in a time-frequency domain using a wavelet-based approach for the period spanning over 1 January 1999 to 8 November 2016. We report evidences of: (a) weaker contagion for Latin American emerging markets during GFC, (b) a strong contagion effect for emerging markets in Europe and the Middle East and (c) a fall in long-run co-movements after GFC, which means by investing in emerging markets, the diversification benefits can be derived in the long run. We report evidence of coexistence of contagion and permanent change in correlation structure.     

Regional spillovers across transitioning emerging and frontier equity markets: A multi-time scale wavelet analysis

The episodic wave of crises experienced across the global financial markets over the past two decades has raised questions surrounding the vulnerability of transitioning emerging and frontier equity markets to exogenous shocks. These markets, by design, have lacked the institutional or financial architecture supporting their capital base compared to more established markets. We make the initial attempt to examine four such stock markets (Saudi Arabia, UAE, South Africa and Israel). We perform multi-timescale analysis using wavelet-based time and frequency decompositions in order to investigate (i) whether the shocks transmitted were pure contagion or fundamental-based and (ii) also whether the dynamic evolution of stock market integration was mainly short-term or long-term. We find that prior to the 2008/09 US subprime crisis, the shocks generated pure contagion in contrast to the subprime crisis that reveals evidence supportive of fundamental-based contagion. Further, when exploring the dynamics of market integration, we find that integration strengthens over time as opposed to any immediate short-term outcome. This supports policies engendered to promote stock market resiliency and stability.     

Weak and strong multimarket bidding rings

We consider bidders who are simultaneously participating in private value second-price sealed bid auctions in multiple markets. While active in each market, each bidder is associated with a unique home market in which it can potentially serve as a ring center. Pairs of bidders can establish bilateral agreements to be members of bidding rings in each others’ home markets. Rings can be weak or strong depending respectively on whether side payments are permitted or not. Weak multimarket rings have been shown to take the form of exclusive groups of completely connected bidders. We consider strong multimarket bidding rings and show that they assume a radically different architecture of dominant groups, stars, and interlinked stars. Since bidding rings are tacit, and therefore unobservable, we develop observable implications of multimarket rings that can detect the existence of collusion as well as its form (i.e., weak or strong).     

Economic integration and stock market dynamic linkages: evidence in the context of Australia and Asia

Countries are becoming economically integrated and it is contended that this will also lead to their financial markets becoming integrated. This contention is important since international financial market integration diminishes portfolio diversification benefits and creates contagion risk. We test this contention in this article in the context of the Australasian region. Australia and Asia have experienced very significant economic integration through a rapid growth in their bilateral trade. We utilize a battery of econometric techniques – cointegration, asymmetric generalized dynamic conditional correlations and panel regression models. As expected, we find that trade intensity significantly drives the interdependence between their stock markets in both the short run and the long run. Thus, given the ever increasing economic integration in this region, this finding implies that their stock markets face the risk of contagion, and that investors in these markets would also be confronted with the prospect of lower diversification benefits.     

DETECTING SHIFT AND PURE CONTAGION IN EAST ASIAN EQUITY MARKETS: A UNIFIED APPROACH

We test for contagion between pairs of East Asian equity markets over the period 1990–2007. We develop an econometric methodology that allows us to test for both ‘shift’ and ‘pure’ contagion within a unified framework. Using both Hong Kong and Thailand as potential shock sources, we find strong evidence of both types of contagion. Therefore, during episodes of high volatility, equity returns are influenced by changes in the transmission of common shocks and additionally by the diffusion of idiosyncratic shocks through linkages that do not exist during normal times.     

Contagion risk for Australian banks from global systemically important banks: Evidence from extreme events

This paper presents evidence that extreme negative shocks for the global systemically important banks (GSIBs) are contagious to Australian banks. Our logit regression models predict transmission of adverse extreme shocks in the distance to default (DD) of GSIBs to the Australian banks. While most previous studies consider contagion across national stock markets, we investigate the degree of contagion risk for Australian banks spreading from GSIBs. Our results point to the critical importance for the Australian Prudential Regulation Authority (APRA) (2015) to closely observe and monitor developments across the major GSIBs and direct appropriate local policy measures accordingly.     

Channels of financial market contagion

This study aims to fill a gap in the current literature by determining which channels of financial contagion are the most significant in transmitting crises between countries. Initial results, using χ² contingency tables, indicate that there is a significant relationship between contagion and the inflation rate and between contagion and financial liquidity. A simultaneous comparison of the channels is then performed using a series of best subset logit regressions. These suggest that a combination of high inflation and an emerging market classification form the most significant subset in increasing the probability of a contagious event.