Debt and Financial Market Contagion
51 Pages Posted: 9 Feb 2015 Last revised: 21 Apr 2021
Date Written: April 20, 2021
We empirically investigate why financial crises spread from one country to another. For our analysis, we develop a new multiple-channel test of financial market contagion and construct indices of crisis-severity in equity markets in order to examine how the transmission of shocks across countries can be related to direct linkages between countries or to common characteristics. Based on network analysis with our proposed multiple-channel test for crises between 2007-2021, we find that the Great Recession is the most pervasive across countries, followed by the European sovereign debt crisis and the recent COVID pandemic, with the subprime mortgage crisis being the least pervasive. Our main finding is that similar public, private, and external debt characteristics are particularly helpful in explaining the transmission of financial shocks during crises. Fiscal deficits appear more important than current account deficits, while stage of economic development matters more than regional linkages, but none of these indicators is as important as debt.
Keywords: Contagion, debt, European debt crisis, financial crisis, Great Recession, COVID, regional linkages
JEL Classification: C51, G01, G15
Suggested Citation: Suggested Citation