Financial contagion in real economy: The key role of policy uncertainty

This paper studies the spread of the Subprime Crisis and the European Sovereign Debt Crisis from Eurozone countries to the real economy by examining 10 sectors in major developed and emerging stock markets. First, we employ Cappiello et al.,Journal of Financial Economics, 2006,4, 537-572 model and copula functions to detect and cross-check the correlations and the contagion thereafter. Second, we uncover evidence of correlation behaviour between policy uncertainty indexes and stock market returns. The results demonstrate that no country and sector was immune to spillover effects, highlighting the limited effectiveness of policy makers for both the Subprime Crisis and the European Sovereign Debt Crisis. The empirical application provides evidence of significant volatility and tail dependence from the financial sector to many real sectors in the U.S. economy. Additionally, there is clear evidence that certain sectors, particularly Healthcare, Telecommunications, Utilities and Technology, were less severely affected by the crisis, as observed by Baur,Journal of Banking & Finance, 2011,36, 2680-2692.

Automated summary

This paper examines the spread of the Subprime Crisis and the European Sovereign Debt Crisis from Eurozone countries to the real economy, finding evidence of correlation behavior between policy uncertainty indexes and stock market returns. The results demonstrate the limited effectiveness of policy makers for both crises, as no country or sector was immune to spillover effects.