217 - Measuring Stock Market Contagion with an Application to the Sub-prime Crisis

DNB Working Papers
Date 28 July 2009

We present a new method to examine financial contagion, defined as a sudden strengthening of shock transmission between financial markets. In particular, we develop a correlation-like measure of synchronicity between markets that is straightforward to implement while being insensitive to heteroskedasticity of market returns. In fact, synchronicity would perfectly coincide with the dynamic conditional correlation (DCC) coefficient if the latter could be calculated using the `true' models for the variance and covariance of the market returns. When analysing the 1997 East Asian crisis and the current sub-prime mortgage crisis, we find no evidence that stock market returns are more contagious during periods of turmoil than during tranquil times. Keywords: Contagion, Heteroskedasticity, Dynamic Conditional Correlation, Sub-prime Crisis, East Asian Crisis.  JEL Classification : C14, F36, G15.