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Contagion as a domino effect in global stock markets

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  • Markwat, Thijs
  • Kole, Erik
  • van Dijk, Dick

Abstract

This paper shows that stock market contagion occurs as a domino effect, where confined local crashes evolve into more widespread crashes. Using a novel framework based on ordered logit regressions we model the occurrence of local, regional and global crashes as a function of their past occurrences and financial variables. We find significant evidence that global crashes do not occur abruptly but are preceded by local and regional crashes. Besides this form of contagion, interdependence shows up by the effect of interest rates, bond returns and stock market volatility on crash probabilities. When it comes to forecasting global crashes, our model outperforms a binomial model for global crashes only.

Suggested Citation

  • Markwat, Thijs & Kole, Erik & van Dijk, Dick, 2009. "Contagion as a domino effect in global stock markets," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 1996-2012, November.
  • Handle: RePEc:eee:jbfina:v:33:y:2009:i:11:p:1996-2012
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    Keywords

    Contagion Stock market crises Interdependence Systemic risk;

    JEL classification:

    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics

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