Financial contagion drivers during recent global crises

Whenever a crisis hits, it is likely to spread simultaneously among stock markets due to their interconnection. This phenomenon, known in the literature as financial contagion, may have a long-lasting effect and manifest itself in herd behavior. A sample of worldwide MSCI (Morgan Stanley Capital International) indices covering the subprime, European, and COVID-19 crises is used to study the presence of contagion, its transmission channels, and potential herd behavior. These channels-real linkages, financial mechanisms, or investor beliefs-are proxied by macrofinance factors. Their impact on stock correlations is tested using an extension of the dynamic conditional correlation model that includes external regressors. Results show evidence of contagion during the three crises, driven mainly by investor expectations and their effects on volatility. Moreover, during the COVID19 crisis, the dissemination of information, as measured through text-based indices, played a significant role in market contagion and led to herd behavior.

Automated summary

Financial contagion, known as the simultaneous spread of crisis among stock markets due to their interconnection, has a long-lasting effect and is manifested in herd behavior. This study examines the presence of contagion, its transmission channels, and potential herd behavior using worldwide MSCI indices covering the subprime, European, and COVID-19 crises. Results show evidence of contagion during all three crises, driven mainly by investor expectations and their impact on volatility. In addition, during the COVID-19 crisis, the dissemination of information measured through text-based indices played a significant role in market contagion and led to herd behavior.