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This paper examines the contagion of the eurozone debt crisis to developed and emerging stock markets around the world. Using the VAR methodology, and changes in sovereign bond yields and stock returns of the crisis countries as proxies for the eurozone debt crisis, this paper finds strong and pervasive evidence of negative contagion from the crisis countries to other stock markets. Consistent with risk-on risk-off hypothesis, changes in sovereign bond yields of crisis countries impact stock returns positively during normal times and negatively during the crisis, providing strong evidence of negative contagion. The impact of equity returns of crisis countries on other equity markets is large and positive during normal times and less positive during the crisis, suggesting evidence of negative contagion and decoupling of stock markets during the crisis. The Asian markets do not show pervasive evidence of contagion from the eurozone crisis.
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Contagion of the Eurozone Debt Crisis
Lalith Samarakoon
Professor of FinanceUniversity of St. ThomasSt. Paul, Minnesota, USA
Annual ConferenceEuropean Financial Management Association
Rome, June 2014
Daily sovereign bond yields of crisis countries
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Daily stock market indices of the crisis countries
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Scope of Investigation
A large body of evidence shows that previous crises
have had contagion effects on stock markets around
the world.
Empirical questions:
• Is there evidence of contagion of the Eurozone debt
crisis to other stock markets?
•What is the nature and the magnitude of such
contagion?
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Related Literature
•King and Wadhwani (1990): contagion of 1987 U.S. market crash across Japan, London, and New York.
•Karolyi and Stulz (1996): large shocks to Japanese and U.S. stock market indices positively impact both the magnitude and the persistence of return correlations.
•Hamao et al. (1990): from New York to Tokyo and London, London to Tokyo, but not in other directions; more pronounced during the market crisis.
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Related Literature
• Bae et al. (2003): contagion is more important in Latin American than in Asia, contagion from Latin America to other regions is more important than contagion from Asia, and that the U.S. is largely insulated from contagion from Asia.
• Baele (2005): contagion from the U.S. to a number of European equity markets during periods of high world market volatility.
• Samarakoon (2011): contagion of U.S. subprime crisis to other developed, emerging and frontier markets. Interdependence is driven more by U.S. shocks, while contagion is driven more by emerging market shocks. Except for Latin America, there is no contagion from U.S. to emerging markets. But there is contagion from emerging markets to the U.S.
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Definition of Contagion
Excessive or incremental impact of shocks of one
market on another during a crisis relative to what is
expected during relatively tranquil times (Edwards,
(2000), Forbes and Rigobon (2002), Bekaert et al.
(2005))
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Sample and Data
Daily stock returns (price changes) of 52 markets
•27 developed markets
•25 emerging markets
Daily sovereign bond yield of crisis countries
•Greece, Ireland, Portugal and Cyprus
Data source: Bloomberg
All returns are measured in U.S. dollar terms.
Sample period 11/01/2003 to 12/31/2012.
•Normal period: Nov 2003 to Oct 2009 (6 years) & Aug 2012 to Dec 2012 (5 months)
•Crisis period: Nov 2009 to July 2012 (33 months)
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Methodology
VAR of stock returns vs. changes in bond yields and stock returns in crisis countries
•Overlapping markets
•Non-overlapping markets
• X is either
• change in the average daily bond yield of crisis countries (∆BYM) or
• average daily stock returns of crisis countries (RM)
• DUS is the U.S. subprime crisis dummy (1 during the period from 9/01/2008 to 03/09/2009 and zero otherwise) 9
tt1t2t1
2
1j
jtjt ε)(DUS)(X)(X)(RβαR
tt2t21-t1
2
1j
jtjt ε)(DUS)(X)(X)(RβαR
Methodology
Measuring contagion
•Overlapping markets
•Non-overlapping markets
DEZ = Eurozone crisis dummy
Granger causality tests
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ttt1t2t1
2
1j
jtjt εDEZ)*(X)(DUS)(X)(X)(RβαR
t1-tt2t21-t1
2
1j
jtjt εDEZ)*(X)(DUS)(X)(X)(RβαR
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Contagion from sovereign bond marketsMarket Normal Crisis Contagion
λ1 λ1 δ
Europe - Developed
Austria 1.25* -1.63*** -2.90***
Belgium 1.44** -1.60*** -3.03***
Denmark 1.80*** -1.37*** -3.16***
Finland 1.47* -1.72*** -3.18***
France 1.73** -1.62*** -3.47***
Germany 1.42** -1.31*** -2.78***
Iceland 0.29** -0.42** -0.72
Italy 1.23 -1.79*** -3.06***
Luxembourg 1.25* -1.35*** -2.56***
Netherlands 1.87*** -1.38*** -3.31***
Norway 2.30** -1.46*** -3.77***
Spain 1.34* -1.88*** -3.35***
Sweden 1.78** -1.65*** -3.44***
Switzerland 0.96* -0.97*** -1.95***
UK 1.78*** -1.12*** -2.95***
All (ex-Iceland) 1.59** -1.47*** -3.10***
Strong
positive
relation in
normal times
turned
negative in
crisis times
due to
spillover of
economic
uncertainty.
Large &
negative
contagion of
about -3%.
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Contagion from sovereign bond markets
Market Normal Crisis Contagion
λ1 λ1 δ
Europe - Emerging
Czech Rep 0.95 -1.43** -2.42**
Hungary 1.76** -2.24*** -3.92**
Poland 1.50* -1.56** -2.99***
Russia 2.59** -1.10*** -3.74***
Turkey 2.65*** -1.12** -3.76***
All 2.02** -1.53** -3.52***
Europe - Frontier
Estonia -0.23 -1.03** -0.78
Malta 0.15 -0.69** -0.84
Slovakia -0.78*** -0.33* 0.46
Slovenia 0.19 -0.78*** -0.95*
All -0.19 -0.70** -0.53
Larger
contagion to
European
EMs of
about -3.5%
No contagion
to European
FMs
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Contagion from sovereign bond markets
Market Normal Crisis Contagion
λ1 λ1 δ
North America
Canada 1.84** -0.72*** -2.60***
USA 1.41*** -0.63*** -2.08***
Mexico 2.00*** -0.76*** -2.71***
All 1.55*** -0.60*** -2.18***
South America
Brazil 3.28*** -1.53*** -4.83***
Chile 1.61*** -0.80*** -2.43***
Colombia 1.59** -0.75*** -2.34***
Peru 1.79** -0.54** -2.29***
All 2.10*** -0.92*** -3.02***
Middle East and Africa - Developed
Israel 1.22* -0.74** -1.96***
Middle East and Africa - Emerging
Egypt 0.10 0.21 0.19
Morocco 0.06 -0.09 -0.13
South Africa 2.52*** -1.22*** -3.75***
All 0.87** -0.27 -1.11**
Sig
contagion to
North
America,
South
American
Ems, and
Israel &
South
Africa.
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Market Normal Crisis Contagion
λ1 λ1 δ
Asia - Developed
Australia 1.08* 0.13 -1.10*
Hong Kong 1.02* -0.09 -1.14**
Japan 1.44** -0.28 -1.75***
New Zealand 0.19 0.11 -0.16
Singapore 0.55 0.02 -0.58
All 0.84* 0.03 -0.87*
Asia - Emerging
China 0.55 0.33** -0.20
India -0.27 -0.13 -0.14
Indonesia 0.79 -0.41* -1.21*
Malaysia 0.16 -0.00 -0.16
Philippines 0.95** -0.15 -1.09***
South Korea 0.99 -0.22 -1.28*
Taiwan 0.68 -0.13 -0.82*
Thailand 0.87** 0.08 -0.81*
All 0.53 -0.10 -0.61
Contagion from sovereign bond markets
Much lower
contagion to
Asian
developed
markets and
no contagion
to Asian
EMs.
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Contagion from equity markets
Market Normal Crisis Contagion
λ1 λ1 δ
Europe - Developed
Austria 0.97*** 0.73*** -0.24***
Belgium 0.78*** 0.66*** -0.11**
Denmark 0.81*** 0.56*** -0.24***
Finland 0.88*** 0.71*** -0.16***
France 0.87*** 0.74*** -0.12**
Germany 0.81*** 0.67*** -0.13**
Iceland 0.16 0.20*** 0.02
Italy 0.84*** 0.79*** -0.05
Luxembourg 0.77*** 0.55*** -0.22***
Netherlands 0.86*** 0.62*** -0.24***
Norway 1.06*** 0.72*** -0.34***
Spain 0.86*** 0.79*** -0.05
Sweden 0.96*** 0.70*** -0.26***
Switzerland 0.65*** 0.42*** -0.23***
UK 0.78*** 0.50*** -0.28***
All (ex-Iceland) 0.85*** 0.65*** -0.19***
Strong
positive
relation in
normal
times turned
less positive
in the crisis
reflecting
some
decoupling.
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Contagion from equity markets
Market Normal Crisis Contagion
λ1 λ1 δ
Europe - Emerging
Czech Rep 0.96*** 0.66*** -0.30***
Hungary 0.95*** 0.84*** -0.11*
Poland 0.90*** 0.71*** -0.06**
Russia 1.10*** 0.63*** -0.47***
Turkey 1.04*** 0.56*** -0.47***
All 0.99*** 0.68*** -0.30***
Europe - Frontier
Estonia 0.46*** 0.41*** -0.04
Malta 0.46*** 0.35*** -0.12***
Slovakia 0.20*** 0.21*** 0.01
Slovenia 0.42*** 0.24*** -0.18***
All 0.39*** 0.31*** -0.08***
Larger
contagion to
European
EMs.
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Contagion from equity markets
Market Normal Crisis Contagion
λ1 λ1 δ
North America
Canada 0.64*** 0.39*** -0.25***
USA 0.45*** 0.33*** -0.11**
Mexico 0.65*** 0.44*** -0.21***
All 0.50*** 0.34*** -0.15***
South America
Brazil 0.97*** 0.57*** -0.39***
Chile 0.53*** 0.38*** -0.14***
Colombia 0.66*** 0.33*** -0.32***
Peru 0.62*** 0.31*** -0.32***
All 0.70*** 0.40*** -0.30***
Middle East and Africa - Developed
Israel 0.56*** 0.43*** -012**
Middle East and Africa - Emerging
Egypt 0.22*** 0.17*** -0.10
Morocco 0.23*** 0.17*** -0.06**
South Africa 0.97*** 0.57*** -0.39***
All 0.51*** 0.32*** -0.19***
Larger
contagion
to South
American
EMs.
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Contagion from equity markets
Market Normal Crisis Contagion
λ1 λ1 δ
Asia - Developed
Australia 0.41*** 0.21*** -0.08
Hong Kong 0.37*** 0.21*** -0.13**
Japan 0.41*** 0.21*** -0.18***
New Zealand 0.19*** 0.13*** -0.03
Singapore 0.19*** 0.14*** -0.03
All 0.33*** 0.19*** -0.10**
Asia - Emerging
China 0.21*** 0.11*** -0.09*
India 0.19*** 0.11*** -0.11*
Indonesia 0.46*** 0.21*** -0.26***
Malaysia 0.14*** 0.13*** -0.03
Philippines 0.32*** 0.21*** -0.11**
South Korea 0.35*** 0.28*** -0.08
Taiwan 0.25*** 0.23*** -0.02
Thailand 0.21*** 0.09*** -0.12**
All 0.25*** 0.18*** -0.09**
Lower sensitivity and lower
Contagion in Asian
markets.
Summary
Changes in sovereign bond yields of crisis countries impacted other equity markets positively in normal times and negatively during the eurozone crisis reflecting spillover of economic uncertainty.
Equity returns of crisis countries impacted other equity markets strongly positively during normal times and less positively during the debt crisis supporting the decoupling hypothesis.
Strong evidence of negative contagion from sovereign bond and equity markets of crisis countries to other equity markets.
The Asian markets do not show pervasive evidence of contagion from the eurozone debt crisis.
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