Contagion Channels of the Subprime Financial Crisis to the NYSE Euronext European Markets using Copulas

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1. IN In a f A go affect count T conta finan study to a “ count return defin A branc weak The s crisis the m S which foreig and Y transm the in const finan T crisis the di Subp Galle Gonz there Long NTRODUC financially gl ood example

ted not only tries. The literature agion has be ncial contagio y, the Forbes “significant i tries)”. From ns of two ma nition of cont According to ches. The fi knesses of mo second branc s transmissio main channel Studies on th h transmissio gn direct inv Yuan (2006 mission. But nvestors’ cha traints impos ncial contagio The literature s. Fry, Martin istribution of rime crisis. I egati (2010) záles-Hermos was contag g-Term Capit CTION lobalized wo of such a p y Asian coun e describes m een one of on (Pericoli and Rigobo increase in c m a practical arkets suffers tagion adopte o Kodres an rst relates e onetary and ch highlights on. Finally, t of transmiss he role of fin on can occu vestment; and 6) argue tha t there is not annel on whe sitions. Our on of the Sub e acknowled n and Tang f returns dur Idier (2011) with Wavel sillo, Martin gion in both tal Managem orld, it seems phenomenon ntries, but al many ways th the main to and Sbracia n (2002) def cross-market standpoint, t s a statistical ed in this pap nd Pritsker exchange rat fiscal policie systemic co the third bran sion. Our stu nancial mark ur: the fundam

d the financi t there is li even consen ether this cha study aims t bprime crisis ges the exist (2010) propo ing the finan

and Guo, Ch let represent n and Tang ( emergent an ment crisis of s that financi n is the prop lso distant co hrough whic opics of stud a, 2003), wh finition of sh linkages aft there is finan lly significan per. (2002), the tes crises w es, thus maki onnections be anch focuses udy concerns kets in crisis mental or re ial channel, ittle evidenc nsus among t annel works t to contribute s to the finan tence of con ose a new se ncial crisis an hen and Hua tations reach (2008) use a nd develope f the second ial crises spr pagation of ountries like ch financial c dy. Even tho hich are ada hift contagion ter a shock t ncial contagi nt increase a

financial c with the impe

ing the coun etween finan on financial this last mec contagion u eal channel, related to in ce that the those studies through port e to this deba cial markets ntagion in fin et of tests ba nd conclude ang (2011), u h a similar c a factor mod ed markets in d half of 199 ead quickly the 1997 As e Brazil, Rus crises spread ough there a apted to the n is one of th o an individu ion when the after an unexp risis contag erfections of ntry vulnerab ncial instituti l markets, na chanism of tr underline two connected to vestors’ beh real channe s that recogni tfolios adjust ate by lookin of NYSE Eu nancial mark ased on the c for existence using Marko conclusion. M del estimated n the Russia 8, in the Bra from country sian financia ssia and eve

d across coun are many de specific nat he most used dual country e correlation xpected event gion literatur f financial m ble to specula ions as the m namely stock ransmission. o main chann o internation haviour. Boy el is the ma nize the prepo tments or thr ng at the me uronext. kets due to th change of co e of contagio ov switching Moreover, D d by GMM t an crisis of azilian crisis y to country. al crisis that n developed ntries. Crisis efinitions of ture of each d. This refers (or group of between the t. This is the re has three markets and ative attacks. main cause of k markets, as nels through nal trade and er, Kumagai ain mean of onderance of rough wealth echanisms of he Subprime oskewness of on during the models, and Dungey, Fry, to show that 1998, in the s of 1999, in . t d s f h s f e e e d . f s h d i f f h f e f e d , t e n

the D Conta It which stabil these or co expec portfo shock they Cons Thus mana A of cri Boye emerg const impo the m evide annou Japan expla (2002 capac mech W and s movi Also essen samp Howe Dot.com cris agion was pa t is indeed r h it occurs ne lity of finan crises sprea ontain the ctations. Sec folio manage k in a count were most n equently, fin , it is import agement and As mentioned ises. It natur er, Kumagai gent markets traints, and rtance of po main means o ence of Karo uncements a nese stock m ain a small 2) finds that city is only hanism throu With respect show that in ng from eme studying th ntially throug ple into three

ever, in the p sis of 2000, articularly str relevant to t eed to be ide cial instituti ad is importa spread of c condly, the e ement. In fac

try, then the needed (Lon nancial instit tant to under financial ins d above, the rally depend and Yuan (2 s. They conc to develop ortfolio rebal of transmittin olyi and Slut

and other pu markets. Kin fraction of t despite evi partial. Fin gh which cri to the Subpr nvestors had erging marke he 2007-08 gh liquidity e periods (yea present paper in the Arge rong in the R est for finan entified. First ons, econom ant for policy crises, espe existence of ct, if stock r advantages ngin and Sol tutions will rstand stock stitutions sup literature do ds on the typ 2006) study clude that thi ed markets lancing to co ng crises (Bo tz (1996) and ublic inform ng, Sentana co-movemen idence of tr nally, there ises propagat rime crisis, C d a flight-to et economies crisis, Long and risk-pre ars 2006-200 r we use stoc entina Crisis Russian and S ncial contagi tly, financial mic growth a y makers so cially by r financial con return correla of internati lnik, 2001; A also be mor markets’ co pervision. oes not alway pe of crisis i the transmis is crisis was through po ontagion fou oyer, Kumag d Connoly a mation do no and Wadhw nt between rade links ex is evidence te (Boyer, K Chudik and F o-safety beha s to bond m gstaff (2010 emium chann 08), and focu ck and bond s of 2001 an Subprime cri ion but, mos l crisis have l and employm that they ca egulating fi ntagion has ation across onal diversi Ang and Ch re exposed t o-movements ys agree on t in question a ssion of the propagated ortfolio reba und weak ev

gai and Yuan and Wang (2 t affect the wani (1994) internationa xplaining co that interna Kumagai and Fratzscher (2 aviour durin arkets of the 0) concluded nels. He use uses on the c returns in a c nd in the Su ises. st importantl large costs, e ment. Theref n take adequ inancial inst strong impli countries in fication are hen, 2002; A o risk in the s in crises so the channels and the statis 1997 Asian to emergent alancing. Em idence of m n, 2006). For 003) conclud co-moveme show that e al stock mar ntagion of c ational mutu Yuan, 2006) 012) use a gl ng that crisis e US and oth d that financ es a VAR m collateralized cross country ubprime cri

ly, the chann especially in fore, underst uate measure titutions and ications for i ncreases afte reduced pre Ang and Bek e presence o o as to impro causing the stical approa Crisis to de t markets thr mpirical stu macroeconom r example, th udes that mac

ent between economic va rkets. Moreo crises, their ual fund hol

). lobal VAR m s, with finan her advanced cial contagi methodology, d debt obliga y analysis; w sis of 2007. nels through terms of the tanding how es to prevent d managing international er a negative ecisely when kaert, 2002). of contagion. ove portfolio propagation ach adopted. eveloped and rough wealth dies on the mic factors as he empirical croeconomic the US and ariables only over, Forbes explanatory ldings are a methodology ncial capital d economies. on occurred , divides the ation market. we follow the . h e w t g l e n . . o n . d h e s l c d y s y a y l . d e . e

conta theor T allow tail c simul some H US su result mech T of fin hypot concl 2. C In thi to dis expla A Sharp metho indica Sbrac T move Mexi Asia. of Ma N coeff volati wron hetero in the agion channe ry as the appr There are adv wing for non-coefficients ltaneously. M e empirical ev Horta, Mende ubprime cris t and add t hanism and th The remainde nancial crise theses of int ludes. CHANNELS is section, w stinguish betw ain our use of

According to pe (1964) a odologies ha ators, GARC cia, 2003). The analysi ement betwe ican crisis us Using the s alaysia, Indo Nevertheless ficient. Forbe ility. As a re ngly indicate oskedasticity e 1987 USA els classifica ropriate stati vantages of u -linear depen measure th Moreover, it vidence has es and Vieir sis to the Eur

that the por hat the flight er of the pap es in stock terest. In Sec S OF FINAN we describe th ween them; w f copulas. o Dungey e and Grubel as been use CH models, M s of correla en markets d sing correlat same method onesia, Philip s, it should es and Rigob esult, when the presenc y bias and co crisis. ation as in B stical tool to using copula ndences, cop e probability allows retu shown to be a (2010) con ropean stock rtfolio rebala t-to-quality p er is organiz markets. In ction 4 the m NCIAL CON he main chan we point out et al. (2004) and Fadner d to measur Markov swit ation coeffic during crises ion coefficie dology, Baig ppines and So be noted bon (2002) h return volati e of contagi onclude there Boyer, Kum o pursue our o as instead of pulas also m ty that stock urns to have adequate to ncluded for a markets of t ancing chan phenomenon zed as follow Section 3 main results NTAGION nnels of finan t the main we , the first em r (1971). Th re contagion tching mode cients has b s. For instanc ents and con g and Goldfaj outh Korea d that there a highlight that ility increase ion. These a e was an abs agai and Yu objectives. f the analysis easure extre k markets s asymmetric describe fina a smaller dat the NYSE E nnel is the is present in ws. Section 2 we describe are presente ncial contagi eaknesses of mpirical test he literature n, including els and correl

been the mo ce, Calvo an clude there w ajn (1998) al during the 19 are some c t this indicat es during cr authors corre sence of cont uan (2006); s of correlati me events. F suffer large and heavy ancial return taset that the uronext grou most impor n all analysed defines the c e the sample ed and discu

ion and sugg f using the co ts of contag has since probit and lations betwe ost common d Reinhart ( was contagio so confirm c 997 Asian Cr aveats when tor depends p ises, the cor ct the correl tagion in the and propose ion coefficie For example increases o tail distribut ns.

ere was cont up. We now rtant crisis t d stock mark channels of t e, methodolo ussed. Finall gest some em orrelation co gion were pe grown and logit model een returns ( n method to 1996) study on in Latin A contagion in risis. n using the positively on rrelation coe lation coeffi e Asian, the M e the copula ents. Besides , asymptotic or decreases tions, which tagion of the confirm that transmission kets. transmission ogy and the ly, Section 5 mpirical tests efficient and erformed by a range of ls, advanced (Pericoli and o assess co-the 1994/95 America and the markets e correlation n the returns fficient may cient for the Mexican and a s c s h e t n n e 5 s d y f d d -5 d s n s y e d

Addit that t More indep linear variab H and M coeff simpl variab of as betwe depen (Emb W have mana intere Conta based foreig valua tionally, Em the correlatio eover, Rache pendence is o r monotonou bles is not fi Hu (2006), R McNeil (200 ficient to me le scalar mea bles in distri sociation be een variable ndence betw brechts et al., When contag significant agement. On esting (Figur F agion can oc d on fundam gn direct inv ations in tha mbrechts et al on coefficien ev et al. (20 only valid fo us transform nite, which m Rodriguez (2 03) suggest easure financ asure of asso ibutional term etween variab es in a parti ween variable , 2003). gion is presen costs, and n this regard re 1). Figure 1 - Pos ccur through mentals, it m vestment. Be at country an l. (1999) and nt is only vali 005) also in or normal dis mations of the may occur fo 2007), Costin the use of cial contagio ociation betw ms. With Co bles and loc

cular range. es with a no nt, it is impo financial co d, the classi ssible channel a fundament means that it esides this m nd in other c d Embrechts id for norma ndicates that stributions; th e variables; or variables w not, Roncalli f copulas to on. In contr ween variable opulas, it is p cal measures It is prefer on-normal di ortant to kno ontagion has ification of ls of transmiss tal channel o is related w more “visible countries. In s, Lindskog a al distribution the equival hat the corre

and that it i with heavy ta i and Teïletch

avoid the l rast with the es, Copulas c possible to e of dependen rable to use istribution th w how it occ strong imp contagion c

sion of the Sub

or an investo with real fac e” channel, a nvestors chan and McNeil ns, which are lence betwe elation coeffi is not define ail distributio he (2000), an limitations o e correlation characterize xtract synthe nce, which m these indic han the linea

curs, mainly plications for channels by bprime financ r related cha tors such as a crisis in a nge their ex (2003, p. 34 e rare in fina een zero cor

icient is affec ed when the ons. and Embrech of using the n coefficient, the relations etic and glob measure the cators for me ar correlation y because fin r internation Boyer et a cial crisis annel. When s internation country cha xpectations o 42) highlight ancial series. rrelation and cted by variance of ts, Lindskog e correlation , which is a ship between bal measures dependence easuring the n coefficient nancial crises nal portfolio al. (2006) is contagion is nal trade and anges stocks on economic t . d -f g n a n s e e t s o s s d s c

grow (2006 rebala mark chang intern shock to red crisis expla betwe I risk a typica betwe a cou in cor A 2.1). in oth signif I have mode imply move highl mark durin A of fin econo where focus mark wth, interest r 6) refers to t ancing (Chan ket hedging ( ge in countri national inve k in one coun duce the risk s but also in ain the propa een Brazil an In turn, the after a shock

al example i een stock pri untry, then a rrelation betw Alternatively This occurs her countrie ficant withdr In our study different im el of Kodres y that the int ements. In co light wealth kets are highe ng crisis perio As mentioned nancial crise omies/marke e the crisis h s particularly kets, making

rates and ris this as portfo

nnel 2.2.1) o Cheung et a ies’ risk afte estors have a ntry, which a k to which th other affecte agation of cr nd Russia du flight-to-qua k, moving fu is the sale of ices and bon simultaneou ween prices y, investors when invest es (Kyle and rawals from m y, we explore mplications f and Pritsker tensity of co ontrast, the m constraints er in periods ods. d above, the es. As one m ets involved, happens, and y on the 2008 use of Copul sk assessmen olio rebalanc or flight-to-qu l., 2009), is r er shocks occ a balanced e also affect ot hey are expo ed countries, rises even am uring the 199 ality channel unds from mo f stocks to bu d prices decr us fall would of both asset may propag tors suffer lo d Xiong, 200 mutual funds e the fact tha for markets’ r (2002), por -movement i models of Ky as the main s of crisis th literature do might expect the type of d the specific 8 Subprime c la theory. nt, and thus cing (Channe uality (Chan related to in cur. In the th exposure to c thers countri osed. They n , leading to a mong countr 8 Russian Cr l is more con ore risky ass uy bonds in reases. Instea d be observed ts. gate crises th osses in the f 01). The nee s. at cross-mar ’ co-movem rtfolio adjust is equal in p yle and Xion n channel of han in bull m

oes not alway t, the prepon f event that i

c method use crisis and how

adjust their el 2.2), whic nnel 2.2.2). T ternational in heoretical m countries’ m ies’ risk, inv not only sell a propagation ries with few

risis (Cheung nnected to lo sets to less r

the same cou ad, if there ar d in stock an hrough weal focus country ed to sell m rket rebalanc ent during c tments by int periods of cri ng (2001), Ca f transmissio markets, beca ys agree on t nderant chan is responsibl ed to measur w it (possibl portfolios a ch can take th The former ch nvestors who model of Kod macroeconom estors adjust assets in the n of the crisi w trade conn g et al., 2009 ocal investor isky assets ( untry. In suc re internation nd bond pric lth constrain y of the crisi may occur du

cing and wea crisis and “n ternational in isis and in pe alvo (1999) on, argue th ause liquidity the channels nnel of trans

e for the cri re transmissi y) contamina accordingly. the form of c hannel, also o adjust port dres and Prit mic risks. On t their portfo e targeted co is. This mec nections, as w 9). rs that adjus (Boyer et al. ch a case, the nal investors ces, implying nts impositio is and have t ue to margin alth constrai normal” per nvestors (Ch eriods of upw and Yuan (2 hat correlatio y constraints causing the smission dep isis, the mom ion. In what ated the NYS

Boyer et al. cross-market called cross-tfolios to the tsker (2002), ce there is a olios in order ountry of the chanism may was the case

st portfolios’ , 2006). The e correlation s flying from g an increase ns (Channel to sell assets n calls or to nts channels riods. In the hannel 2.2.1) ward market 2005), which ons between s are present propagation pends on the ment in time follows, we SE Euronext . t -e , a r e y e ’ e n m e l s o s e ) t h n t n e e e t

3. D 3.1. T This count Intern Both logar T the st long first t of the W Fry e ackno conse 2007 timel the pr of th close signif T Henc took p fair a        2 _Bloo 3 _Bloo PTG1T 4 _{At th} But in 5 _Holid 6 _Hort Augus DATA AND THE DATA study analy tries: Belgiu national (MS indices are o rithm differen The data cov tarting date o term Greek time in ten y e fact that we We chose 1s et al. (2010) owledges th ensus date of as the begi ine of financ roperty price e events dur d two mutu ficant event. The date 1st ce, our series

place and 58 amount of inf         omberg tickers omberg ticker TR Index. he end of Feb n August 2007

days were exc ta et al (2010 st 2007 is app

METHODO

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yses how the um, France, SCI)2 _{stock in}

observed dai nces of the d vers the peri of the Sovere

Debt from A years. The de

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st _{August 20} ) claim that hat “…the b f the crisis)… inning of th cial bubbles e bubble eme ring the 200 ual funds ex August 200 s has a total 88 observatio formation for                  s for the stock rs for the bon bruary 2007 th the fall in sto cluded. 0) tested altern ropriate and d OLOGY e US Subpri the Nether ndices and th ily and are ex daily market i od from 3rd eign Debt Cr A- to BBB+, ecision to en terested in st 07 as the sam “the US Su urst of the …”. The auth he crisis. For during the S erged in Aug 06-2008 peri xposed to th 07 is therefor of 1230 obs ons after the r this empiric

       

k indices: MXU nd indices: US here was the f ock markets wa

native dates f does not alter

ime financia rlands and P he 1-3 year T xpressed in l indices. January 200 risis. Indeed, , putting the nd the sample tudying the S ample breakp ubprime cris US Subprim hors that esti

r example, u Subprime cr gust 2007. S iod. Note als he Subprime re used to sp ervations5_{, w} burst of the cal applicatio S Index, MXB SG1TR Index, first correction as much more for the beginn the results ob al crisis was Portugal. W Treasury bon ocal currenc 05 to 7th _Dec on 8th _Decem rating of th e in Decemb Subprime cri point in line sis began in me mortgage imated the da using recurs isis, Phillips See also Long

so that in A e crisis, whi

plit the samp with 642 obs Subprime bu on6_. E Index, MXFR , BEG1TR Ind n in the stock e pronounced ning of the cri btained.  transmitted e use the M nd indices fro y. As usual, cember 2009 mber 2009 F e Greek deb ber 2009 mu sis in this pa with the exi mid-2007… e bubble wa ate of the bre ive-type stat and Yu (20 gstaff (2010) August 2007,

ich was see

ple into pre-c servations be ubble; this co R Index, MXN dex, FRG1TR market relate than in Febru sis, and concl

to the NYS Morgan Stan rom Bloombe market retur

which is as Fitch cut the bt below leve ust be unders aper. isting literatu …” and Gall as in Augus eak also indi atistical tests 011) found e ), Table 2, fo , the Bank B en by the m crisis and cr efore the stru onstitutes a b

L Index and M Index, NEG1T ed with the Su uary 2007.

luded that the

SE Euronext nley Capital erg/EFFAS3_. rns equal the sumed to be rating of the el A- for the tood in light ure4_{. In fact,} egati (2010) st 2007 (the icate August to date the evidence that or a timeline BNP Paribas markets as a risis periods. uctural break balanced and MXPT Index. TR Index and ubprime crisis. e choice of 1st t l . e e e e t , ) e t e t e s a . k d d . t

3.2. T To ex risky T joint depen funct (1959 F name and i about distri Schm Kend of tra T crisis Step order Gonz (Stam adjus Step Assum by m Notic distri Step Funct Then        7 _This two st the se previo THE METH xplore the in returns and The concept distribution ndence betw tion in which 9), Firstly, it is ely the Kend

inferior (low t the degree

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1: Using the

r to remove zalo and Olm mbaugh, 199 stment, the st 2: The serie ming that th maximum lik ce that the bution that b 3: The mar tions for Ma n, using the         s method was teps, as we e econd step, th ous testing of HOD nformation t bonds, we u of copula w n function o ween variable h the objects possible to all’s tau (

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rginal distrib argins (IFM) AIC, the be                  s proposed by xplain later in he parameters the adjustmen that is availa se copula the was first intro

of random v es (the so ca are the marg

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u₁ d ,..., 1 . Foll ation betwee ally, the supe can be obtai tremes of th n (2006), Pa ail coefficie markets and ain channels models to th the series ( cant bias in obon, 2002) ns. risis and a c ibutions for b ne for extre on for the r eria (AIC). opulas by th sis and the cr ng copulas: g the copula p of marginal dis method is tha tributions of refers to the structure of

)

d u ,..., 1 is a lowing Sklar en variables, erior (upper) ined to infer he bivariate atton (2002), ents and the the channels s of financial he returns in (Dias, 2004; n the results . After this crisis period. both periods eme values). returns. The he Inference risis periods. Gaussian, t-parameters in stributions. In at it allows for f e f a r , ) r e , e s l n ; s s . s . e e . -n n r

Stude Rodri I copul consi a b c d e Step formu Ω. T then s The f the d focus return when ent, Frank, iguez, 2007) In order to o las, we propo ists of: a) Through distributi joint vect b) Randoml data; c) With the d) Repeat s paramete

( )

r ( ∧ = Ω e) The estim matrix

V

∧ 4: Using the ulating speci The correspo serve to obta first scenario definition of s of the crisis ns of countr n compared t Gumbel, C ).

obtain the par ose the boots

the IFM me ons and the v tor of parame y draw with sample obta steps b) and rs as ₁

(

r

∧

β

2 1(r), (r) ∧ ∧

β

β

mators’ stand

∑

= ∧ −

_Ω

=

R r

R

V

1 1

₍

e bootstrapin ific hypothes onding boots ain p-values f o consists of Forbes and R s. If contagio ry i, measure o the period layton, Gum rameters’ va strap techniq ethod, obtain vector of par eters is defin h replacemen ined in b), re d c) R tim

)

r

, ₂

(

r

)

∧

β

' )) ( ), r

θ

∧ ; dard-errors a ∧ ∧ ∧

Ω

Ω

−

Ω r

(

)

)(

ng results for ses of interes strap distribu for the propo testing the e Rigobon (20 on exists, the ed by

τ

from prior to the c Be : : 1 0 = ⎪⎩ ⎪ ⎨ ⎧ i H H

τ

τ

mbel-Surviva ariance-covar que develope n the vector rameters

θ

∧ r ned as

Ω

∧

=

(

β

nt a sample o e-estimate

β

mes (with

R

=

and

θ

∧

(r

)

, are defined a ∧

Ω

−

Ω r

₍

₎

₎

'_. r the estimate st considerin utions of the osed tests. N existence of 002). Natural en the correla m the estim crisis. The hy Neth Fra, el, ) ( ) ( − − i i p crisis crisis

τ

τ

τ

τ

al Gumbel riance matrix ed by Trivedi of parameter related to the ' 2 1

,

,

)

∧ ∧ ∧

θ

β

β

; of observatio 1

β

,

β

₂ and

θ

1000

=

) and r=1,…,R. as the squar ed copulas, s ng the quanti e estimated c ext, we desc contagion in lly, the US s ation betwee mated copulas ypothesis of Por , ) ( ) ( > ≤ − − i i crisis pre crisis pre and Clayton x and other m i and Zimme rs

β

ˆ

₁and

β

ˆ

₂ e copulas dep

ons from the

, and store th d denote the The rth ve

re-roots of th

tudy the cha ities

τ

,

λ

_U an copula measu ribe the tests n the Subprim stock market en the US sto s, increases interest is th 0 0 n-Gumbel ( measures ass er (2005). Th 2 from the tw ependence m e original filt he point estim e rth estima ector of pa he main diag annels of tran and

λ

_L, whic ures of depe s under study me financial t is understo ock returns a during the c herefore: Dias, 2004; sociated with his technique wo marginal easures. The tered returns mates; ation of the arameters is gonal of the nsmission by h depend on endence will y. crisis, using ood to be the and the stock crisis period ; h e l e s e s e y n l g e k d

where perio If the which transm the fo count betwe obtain lower the u reach these decre mark prices Rejec const T as us main count intern mark the sa will s decre        8 _Noti invest e

τ

crisis(i)_me d. e null hypoth h channels mit the crisi ormer case, t try i is large een markets ned directly r asymptotic upper asympt hes an extrem coefficients eases simulta kets during la s:

cting the nul traints.

The third tes ual, that bon channel of t try portfolio national inve kets simultan ame. On the substitute sto ease during th         ce that the c tors sell dome

easures the c hesis is rejec of contagion s due to wea the correlatio er in periods in periods from the est c tail coeffici totic tail coe me value giv s measure t aneously. H arge falls in ll hypothesis st looks at th nds are the l transmission o re-balancin estors are tak neously, impl other hand, ocks with bo he crisis.                  hannel based stic bonds or correlation b cted, it can b n were activ alth constrai on between s of crisis th of extreme timated copu ient,

λ

_L, is u efficient,

λ

_U ven that the o

the probabil Hence, the te n prices with B 1 0 = ⎪⎩ ⎪ ⎨ ⎧ i H H s in this seco he interaction less risky inv , this test all ng or to do king funds ou lying that th if domestic onds.8 _{As a}         on internatio shares to buy between the be concluded ve. Therefo ints (Channe the US stock han in period changes in ulas. Namely used; and for

U. These coe

other market lity that two est compare h the correla Net Fra, Bel, ) ( : ) ( : − − i i crisis L crisis L

λ

λ

λ

ond test mea

n between st vestment. If lows us to di omestic inv ut of a count he correlation investors ar result, the c onal investors y safer foreign US and cou d that contag re, the seco el 2.1) or por k market retu ds of marke prices, we y, for periods periods of l efficients me t has already o markets s es, in the cri ation betwee Por th, 0 ) ( 0 ) ( > ≤ i i crisis U crisis U

λ

λ

ans that the

tock and bon test 2 confir istinguish if t estors’ flyin try, they will n between b re flying to q

orrelation be

may also incl bonds or sha

untry i stoc

gion existed. ond test asse

rtfolio rebala urns and the t boom. To use the asym of significan arge increase easure the p y reached thi uffer very h isis period, n markets d crisis is tran nd markets du rms that por the transmiss ng-to-quality l leave from oth markets quality inside etween stock lude a flight-t res. ck returns, f . The next st esses wheth ancing (Chan e stock mark measure the mptotic tail ant falls in th es in asset p probability th is value. In o high price the correlati during large nsmitted thr during a crisi rtfolio rebala sion occurs d y. On the o

both the sto will increas e the same c k and bond m

to-quality beh

for the crisis

tep is to test her investors nnel 2.2). In ket returns of e correlation coefficients he market the rices we use hat a market other words, increases or ion between increases in ough wealth s, assuming, ancing is the due to cross-one hand, if ock and bond se or remain country, they markets will aviour, where s t s n f n s e e t , r n n h , e -f d n y l e

Given and b with hypot rebala qualit 4. E In thi crisis 3rd _Ja finan A (stand autoc Table hetero n the above, before the cri

)

(

,Stock

i

Bond

τ

thesis is rej ancing that o ty is the main EMPIRICA is section, we s to the NYS anuary 2005 ncial crisis. As expected dard Ljung-correlation fu e 1), the filte oskedasticity , the third te isis:

)

as the corr ected, this i originates the n mechanism AL RESULT e apply the m SE Euronext to 7th _Decem d, the origina -Box-Pierce unctions wer ered returns w y. Table 1 – A

Note: the first

est compares F Bel, : : 1 0 = ⎪⎩ ⎪ ⎨ ⎧ i H H cr Bo cr Bo τ τ relation betw indicates tha e crisis conta m explaining TS AND DIS method descr countries. W mber 2009 an al return seri and Engle re analysed) were recover Adjusted ARM model refers to the correlat P Neth, Fra, ) ( ) ( , , − − i i risis Stock ond risis Stock ond τ τ ween the bo at it is intern agion. If the n the propaga SCUSSION ribed above We use daily nd taking 1st _A

ies have seri e tests wer . After adju red confirmin

MA-GARCH m

o the mean and

tion of stock or ) ( ) ( , , − − i i crisis pre Stock Bond crisis pre Stock Bond τ τ

ond and stoc national inv null hypothe ation of the cr

to the transm bond and sto August 2007

ial correlatio e performed sting for the ng the absen models to the the second to th k and bond m 0 0 ≥ <   ck market o estors that a esis cannot be risis to the st mission of the ock returns c 7 as the starti n and condi d and auto e best ARMA ce of autocor returns under he conditional v markets duri of country i. are behind t e rejected, th tock market. e US Subpri covering the ing date of th itional hetero ocorrelation A-GARCH m orrelation and r study variance. ng the crisis . If the null the portfolio hen flight-to-me financial period from he Subprime oskedasticity and partial models (See d conditional s l o -l m e y l e l

Figur return volati sudde Gove the pe We n funct distri preva distri did n return re 2 provide ns, obtained ility of retur en increase ernment. The eak in bond m

now fit the pa tions selected bution durin alence of th bution (Man not provide th ns. es additiona d with the H rns during th in April 20 e peak of vo markets, coin Figure arametric dis d for each re ng the crises he latter fun ndelbrot and he best fit is l informatio Hodrick-Pres he crisis is e 008 when F latility in sto nciding with e 2 – Volatility stribution fun turn. With th period, for t nction sugge Hudson (200 in any case a on where we scott filter, a evident. Alth Fannie Mae ock markets h the failure o y trends of filt nctions to th he exception the remainin ests the exi 04) address an indicator e can observ as in Horta hough the in and Freddie is reached in of Lehman B tered stock an e filtered ser n of the Frenc ng series it w istence of h this issue). T that there is ve the volat et al. (2010 crease is init e Mac were n November Brothers Bank nd bond return ries. Table 2 ch stock retu was chosen th heavier tails The fact that no asymmet atility’s trend 0). The incr itially gradua e bailed out r 2008, two m k. ns contains the urns, which h he logistic fu s than in th the Gumbel try in the dis

d of filtered rease in the al, there is a by the US months after e distribution has a normal unction. The he Gaussian l distribution stributions of d e a S r n l e n n f

Next, for th return param Kend R excep Anoth signif corre extrem betwe contr corre strong the N T are in the ri indice It can all pa hypot of tra , we adjust c he selected ns for two meters (

θ

,

ν

dall and the a Regarding th ption. This m her relevant ficant. For i lated in extr me ups and een stock an rast, and as lations rang ger for large Netherlands, B Turning now n general sym ight. In thes es increase. I n also be infe airs of stock thesis tests t ansmission. copulas to th copulas for countries an

ν

_and

w

) and asymptotic ta he period of means that th aspect is th instance, it eme situatio d downs of nd bond mark expected, s ing between er markets, w Belgium and w to the crisis mmetric. On se two cases In addition th erred from T markets, wh to evaluate th he bivariate s the pre-cris nd stock an d several me ail coefficien f pre-crisis re here is symm at the extrem can be obse ns, presentin 14.16% (

λ

_U kets within a stock marke n 32.3% for with the degr d Portugal.

s period, Tab nly the copul , in turbulen he Gaussian Table 3 that th hich suggests he possibility series of filt sis and crisis nd bond retu easures obtai nts

λ

_U and

λ

eturns, the t metry in the me dependen erved that th ng a probabil U=

λ

L= 0.14 a country is n et returns ar France/US ree of correl ble 3 shows t las for US/F nt markets, t copula is the he Kendall’s s the existen y of financia tered returns s periods an urns for a ined from the

L

λ

(standard -Student cop distribution nce between he US and lity of simult 416). Moreo negative, ran re positively and 16.0% lation decrea

that the estim FRA and US/

the correlatio e most chose s

τ

measure nce of contag al contagion . Table 3 sho nd, at each p single count e estimated c errors in par pula best fits of returns d series, as as French stock taneous mov over, it is cl nging betwee y correlated for Portugal asing in the f mated copula /POR stock on between en for the cris

increases du gion. Finally and to deter

hows the resu period, comb try. We pre copulas, nam renthesis). s the data, w during pre-cr ssessed by

λ

_U k markets a vement durin lear that the en -8.4% and d across cou

l/US. The c following or

as for the biv returns prese markets is h sis period. uring the cris y, we apply t rmine the m ults obtained bining stock esent copula mely the

τ

of

with just one risis periods.

U and

λ

L, is

are the most ng periods of e correlation d -11.8%. In untries, with orrelation is rder: France, variate series ent a bias to higher when

sis period for the proposed ain channels d k a f e . s t f n n h s , s o n r d s

To as in the for

Δ

ssess the exis e Kendall’s t

τ

Δ

, we cons stence of con tau during th sidered R=10 Ta ntagion, it is he crisis, deno 000 replicatio able 3 – Select necessary to oting it by

Δ

ons of the bo ted copulas o analyse the

τ

Δ

. In order ootstrap proc

e sign and sig to construct cedure. For e gnificance o t the probabi each replicat of the change ility function tion, a value e n e

was o p-val T all m perio They count conta Given conta main simila theor        9 _The obtained for lues of the te Table 4 show markets at a s d, the null o y also obtaine tries analyse agion general n that contag agion channe channel of ar to the co retical model Tab         p-values are o

τ

Δ

. Afterw st for the nul ws the result significance f no contagi ed smaller pr ed, with the lly increased

Tab

gion existed els. The seco

transmission onclusion of l of contagion le 5 – Results                  obtained for a wards, these ll of no conta s for the firs

level of 1% on had large roportional i exception o d as the crisis ble 4 – Results during the S ond test was

n of the cris f Boyer et a n of Kodres of the second         an unilateral te 1000 values agion: H0:

Δ

t test. The co . In Horta et er significanc increases in of Belgium. s developed. s of the first te Subprime fina performed; sis, as oppos al. (2006) fo and Pritsker d test: wealth c est, reflecting were sorted

0

≤

Δ

τ

9_. onclusion is t al. (2010), ce levels, rea the Kendall’ It can there

est: does conta

ancial crisis, this indicate sed to wealt or the Asian (2002). constraints ve the probability d in an increa that financia with a smal aching 8.6% s tau during efore be con agion exist? we can go o es that portfo h constraints crisis and ersus portfolio y mass to the asing order t al contagion ller sample f for the Portu g the crisis pe ncluded that on to determ olio rebalanc s (See Table in consonan o rebalancing e left of

Δ

τ

=

to obtain the is present in for the crisis uguese case. eriod for the the signs of

ine the main cing was the e 5). This is nce with the

0

=

. e n s . e f n e s e

At th count was p did n mark his point, on try movemen performed an not increase ket portfolio r Tab

nly one ques nts or to dom nd its null hy during the c rebalancing. ble 6 – Results stion remain mestic invest ypothesis wa crisis (Table s of the third t ns unanswere tors flying to as not rejecte 6). This ind

test: cross mar

ed: was the o quality? To ed, i.e., the c dicates that f rket rebalancin portfolio re o answer thi orrelation be flight-to-qua ng versus fligh ebalancing d is question, t etween stock ality prevails ght to quality due to cross-the third test ks and bonds s over cross -t s

-5. C Exist most wealt cross contr paper Subp techn the K A corre Belgi inside E Furth wealt risk th F finan geogr a stra system CONCLUSI ting studies o important ch th constraint -market reba ributions, the r contributes rime financi nique is prop Kendall’s tau Among the lated with t ium and Por e a given cou Evidence al hermore, the th constraint hrough the s From the ab ncial crisis th raphic divers ategy that pa m. ON on contagion hannel of tra ts or portfoli alancing or f ere is little e s to this un ial crisis to f posed to obta dependence four Europ the US mar rtugal. More untry is nega lso shows contagion to s; the adjustm substitution o bove results, he increase o sification. Ho aid off in th n in financial ansmission. T o rebalancin flight-to-qua empirical ev derstanding four Europea ain the stand

measure, an ean markets rket. France eover, it is fo ative. that there ook place m ment in port of stocks by b it can be s of dependen owever, in th at it reduced l markets co Through this ng. Furtherm ality within t vidence on h through the an stock mar dard errors of nd also to per s analysed, has the lar found that th

was financi mainly throug

tfolios occur bonds (flight said that the nce between he initial stag d risk and c nclude that t s channel, co more, portfoli the same cou how the inve e study of t

rkets, using t f parameters rform the hyp

it is found rgest correla he dependenc ial contagio gh portfolio r rred at the na t to quality). present stud national sto ges at least, p ontributed to the investors ontagion may o rebalancin untry. Despit estors’ induc he channels the theory of , the asympt pothesis tests

that the big ation, follow ce between s on in the f rebalancing a ational level, dy shows th ock markets portfolio dive o a more sou s’ induced ch y occur due t ng may be do te the severa ced channel s of transmi f copulas. T totic tail coe

s. ggest marke wed by the N stock and bo four analyse as opposed t , with invest hat during th reduced the ersification t und and stab

hannel is the to investors’ ominated by al theoretical works. This ssion of the he bootstrap fficients and

ets are most Netherlands, ond markets ed markets. to investors’ ors reducing he Subprime e benefits of to bonds was ble financial e ’ y l s e p d t , s . ’ g e f s l

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