Transmission of the U.S. Subprime Crisis and the European Sovereign Debt Crisis to Emerging Markets

This paper evaluates the transmission of the U.S. Subprime Crisis and the European Sovereign Debt Crisis to sixteen emerging markets. A GARCH model is formulated to test for the transmission of shocks and for transmission effects through financial channels. The bankruptcy of Lehman Brothers and the Greek debt restructuring are used as breakpoints for these sub-periods. The U.S. stock market has a significant transmission effect on emerging markets at the early stage of the crises and normal time, whether in terms of a contemporaneous day or a one-day lag time. The stock markets in emerging market tried to loosen their ties or reduce the connection with the Dow Jones after the bankruptcy of Lehman Brothers. Most emerging markets also attempted to moderate the effects of the crises and loosened their relationship between their local currencies and stock markets. Before the bankruptcy of the Lehman Brothers, all Asian emerging markets in our samples had already started to show significance to Spanish CDS. It is evident that the U.S. Subprime Crisis and the European Sovereign Debt Crisis had linkage. Finally, the decoupling phenomenon is quite obvious after the Greek debt restructuring.