Title: Financial market interdependence, contagion and jumpy risk exposure
Summary: This paper measures the degree of common movements across European stock markets and aims to understand possible contagion effects when shocks occur.
Authors: Gerdie Everaert (Ghent University) and Martin Iseringhausen (ESM)
Abstract: We develop a factor model to jointly measure financial market interdependence and contagion effects. Countries’ exposure to the common factor is composed of a slow-moving trend, measuring cross-market linkages during ‘normal times’ and a regime-switching component, measuring excess sensitivity often indicative of contagion. When estimating the model using daily excess returns for 19 European stock markets over the period 1995–2025, we find a decreasing degree of interdependence after the Great Recession. Moreover, we identify contagion days in multiple countries, often linked to well-known market events. Finally, allowing for regime changes in the factor loadings can help improve forecasts of downside risk.
Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.
Keywords: Bayesian analysis, factor model, regime switching, stock markets
JEL codes: C11, C58, G15