Empirical Evidence on Spatial Contagion between Financial Markets

Abstract

We say that there is contagion from market X to market Y if there is more dependence between X and Y when X is doing badly than when X exhibits typical performance, that is, if there is more dependence at the loss tail distribution of X than at its center. This alternative definition of contagion between financial markets was introduced in Bradley and Taqqu (2004), where a test for contagion based on local correlation was presented. Using this test, we find evidence of contagion from the US equity markets to equity markets of several developed countries. We also find evidence of flight to quality from the US equity market to the US government bond market. We make the software written in support of this work freely available and describe its use in the appendix.

Keywords: Contagion, local correlation, correlation breakdown, crisis period

JEL Classification: C12, C14