Working Paper: CEPR ID: DP2517
Authors: Alessandra Bonfiglioli; Carlo A. Favero
Abstract: In this paper we concentrate on the potential consequences for the European stock market of a correction of the US stock market. We conduct our analysis by explicitly considering the distinction between interdependence and contagion. By considering a Vector Error Correction Model, in which stock returns tend to restore an equilibrium relationship between the forecast earnings yield on common stocks and the yield on bonds, we provide separate answers to the following questions:Is there long-term interdependence between the US and Europe, i.e. does the equilibrium for European shares depend on the equilibrium for US shares?Is there short-term interdependence and contagion between US and European stock markets, i.e. do short-term fluctuations of the US share prices spill over to European share prices and is such co-movement stable in the event of high volatility episodes?
Keywords: Contagion; Interdependence; Stock Market; Structural Models
JEL Codes: F30; F40; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| US stock price fluctuations below 8% (E32) | European stock prices (G12) |
| US stock price fluctuations (E39) | European stock prices (G12) |
| US stock price fluctuations above 8% downward (G12) | European stock prices (G12) |
| US stock price fluctuations above 8% upward (E32) | European stock prices (G12) |
| US market correction (G18) | European markets (G15) |
| US stock prices (G12) | European stock prices (G12) |
| long-term interdependence (F55) | European stock prices (G12) |