Managing Contagion Risk During Economic, Financial And Political Shocks

The present article tackles on a current issue, namely that of financial contagion of the capital markets, a result of instability or financial shocks, such as financial crisis. Moreover, we study the way financial contagion occurs, a phenomenon facilitated by the connections between countries, based on the economic relations, commerce and common lenders. The study object is the Romanian capital market and PIIGS countries markets.We calculate a spillover index, we find which countries are vulnerable, which shocks lead to contagion, as well as their persistence, and also we find moments of crowd effect in the investment community. The investors’ behaviour, their reaction to shock and information asymmetry can fuel shock spreading. We find that the contagion issue is more profound, as it expands through many regions, and, therefore, it is important to find correlations between the countries, in order to reduce contagion effects, proving that the financial markets have underestimated this type of risk generated by the interconnections between countries. This information is necessary to define an efficient management style in view of reducing the contagion risks.