Financial Contagion During Stock Market Bubbles
42 Pages Posted: 12 Feb 2021
Date Written: October 10, 2020
We investigate the role of bubbles on financial contagion using a set of developed economies. First, using the recursive flexible window right-tailed ADF-based procedure, we date stamp bubble periods in stock index series. Second, we capture contagion with a DCC multivariate GARCH framework. In a third step, we construct a panel by pooling across the time-series dynamic conditional correlations and bubbles to estimate various dynamic panel specifications that consider the endogenous nature of bubbles. We find statistically significant decreases in the dynamic correlations during periods of bubbles, which shows that the financial contagion between pair of countries diminishes when any of the two countries in the pair is going through a bubble period. This implies that during bubble periods investors are looking for an investment opportunity within their economy and rely less on international diversification. However, decrease in contagion between two economies could provide ample diversification opportunities for portfolio managers.
Keywords: Financial contagion; Stock markets; Bubbles; Dynamic correlations, Dynamic panels
JEL Classification: F30; G15
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