Financial Contagion: A New Perspective (and a New Test)
Download PDF: Working Paper 12
This paper analyses the mechanism of financial shocks propagation and how extraordinary jumps in financial market uncertainty alter it substantially.
Author: Matteo Cominetta | European Stability Mechanism
Abstract:
Contagion has mostly been interpreted and tested as a break from a stable linear correlation of financial markets caused by an extraordinary shock. This paper argues that quantile regression can provide a tool to investigate alterations in other features of financial returns’ distribution caused by extraordinary shocks, thus providing additional understanding of the mechanism of financial shock propagation and its instability. Applying the technique to stock market returns, we find evidence that jumps in uncertainty have powerful contagious effects of a form different from an increase in markets’ correlation. These effects would not be detectable in standard contagion tests that search for increases in market correlation.
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JEL codes: F30, C10, G10, G15