Contagion, interdependence and global crisis: Evidence from equity markets

This paper examines the transmission of shocks between 55 global equity markets over the major crisis episodes, such as the 2007–2009 global financial crisis and the COVID-19 pandemic. Employing a factor model incorporating U.S., global, and domestic market factors, we find five dominant transmission channels: domestic banking sector exposure, banking system default risk, external exposure, domestic market fundamentals, and global equity market volatility. Our results show an increase in market co-movement during crises, largely explained by the U.S. factor, followed by the global factor. Some evidence for non-fundamental contagion is also present in certain markets. Though risk transmission channels differ by region and factor, the findings suggest that external exposures through international banking linkages and financial integration are the major conduits for contagion. Global equity market volatility and current account imbalances also figure prominently as sources of spillovers, particularly within European markets. Overall, our analysis highlights the predominant role of external factors and the strength of domestic macroeconomic fundamentals in determining shock transmission during crises. These results provide important guidance to investors for effective portfolio strategies and policymakers for mitigating contagion risks, highlighting the role of macroeconomic stability and cautious financial integration in minimizing vulnerability during turbulent times.