Working Paper: NBER ID: w17121
Authors: Geert Bekaert; Michael Ehrmann; Marcel Fratzscher; Arnaud J. Mehl
Abstract: Using the 2007-09 financial crisis as a laboratory, we analyze the transmission of crises to country-industry equity portfolios in 55 countries. We use a factor model to predict crisis returns, defining unexplained increases in factor loadings and residual correlations as indicative of contagion. We find statistically significant evidence of contagion from US markets and from the global financial sector, but the effects are economically small. By contrast, there has been substantial contagion from domestic equity markets to individual domestic equity portfolios, with its severity inversely related to the quality of countries' economic fundamentals and policies. This confirms the old "wake-up call" hypothesis, with markets and investors focusing substantially more on country-specific characteristics during the crisis.
Keywords: Contagion; Financial Crisis; Equity Markets; Wake-Up Call Hypothesis
JEL Codes: G01; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| U.S. markets (N22) | contagion to country-industry equity portfolios (F65) |
| global financial sector (F65) | contagion to country-industry equity portfolios (F65) |
| domestic contagion (F65) | increase in factor loadings with respect to domestic factor portfolio (F29) |
| quality of economic fundamentals and policies (E66) | domestic contagion (F65) |
| wake-up call hypothesis (G14) | reassessment of vulnerabilities of market segments (R20) |
| political risk (P26) | greater contagion (F65) |
| current account deficits (F32) | greater contagion (F65) |
| unemployment (J64) | greater contagion (F65) |
| government budget deficits (H69) | greater contagion (F65) |
| debt and deposit guarantees (H81) | reduced contagion effects (E44) |