International Financial Contagion During the Subprime Crisis: Evidence from UK Financial Markets

Behavioral Finance: The Coming Of Age

46 Pages Posted: 9 Mar 2021

See all articles by Zijun Liu

Zijun Liu

Bank of England

Yang Zhou

Wuhan University - School of Economics and Management

Zhiping Zhou

Tongji University - School of Economics and Management

Date Written: May 1, 2019

Abstract

In this paper, we investigate the dynamics of contagion from the US low grade asset-backed securities (ABSs) market to UK financial markets during the 2007 subprime mortgage crisis and identify the contagion channels using both a single-state vector autoregressive (VAR) model and a Markov-switching vector autoregressive (MSVAR) model. We show that a shock to the US low grade ABS market results in a significant and persistent effect on the yields of UK financial assets, which demonstrates the existence of contagion. Moreover, contagion episodes mainly occur during periods of financial crisis. We also find that the contagion effects of the US lower grade ABS market are transmitted to UK financial markets through a number of channels, including flight to liquidity, risk premium, flight to quality, and correlated information.

Keywords: International contagion; Asset-backed securities; UK financial markets

JEL Classification: G01; G12; G14

Suggested Citation

Liu, Zijun and Zhou, Yang and Zhou, Zhiping, International Financial Contagion During the Subprime Crisis: Evidence from UK Financial Markets (May 1, 2019). Behavioral Finance: The Coming Of Age, Available at SSRN: https://ssrn.com/abstract=3769738 or http://dx.doi.org/10.2139/ssrn.3769738

Zijun Liu

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Yang Zhou

Wuhan University - School of Economics and Management ( email )

Wu Han, Hu-Bai 430072
China

Zhiping Zhou (Contact Author)

Tongji University - School of Economics and Management ( email )

Siping Road 1500
Shanghai, Shanghai 200092
China

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