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Measurement of contagion in banks' equity prices

  • Gropp, Reint
  • Moerman, Gerard

This paper uses the co-incidence of extreme shocks to banks’ risk to examine within country and across country contagion among large EU banks. Banks’ risk is measured by the first difference of weekly distances to default and abnormal returns. Using Monte Carlo simulations, the paper examines whether the observed frequency of large shocks experienced by two or more banks simultaneously is consistent with the assumption of a multivariate normal or a student t distribution. Further, the paper proposes a simple metric, which is used to identify contagion from one bank to another and identify “systemically important” banks in the EU. JEL Classification: G21, F36, G15

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Paper provided by European Central Bank in its series Working Paper Series with number 0297.

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Date of creation: Dec 2003
Date of revision:
Handle: RePEc:ecb:ecbwps:20030297
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  1. Reint Gropp & Anthony J. Richards, 2001. "Rating Agency Actions and the Pricing of Debt and Equity of European Banks: What Can we Infer About Private Sector Monitoring of Bank Soundness?," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 30(3), pages 373-398, November.
  2. Gropp, Reint & Vesala, Jukka & Vulpes, Giuseppe, 2006. "Equity and Bond Market Signals as Leading Indicators of Bank Fragility," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(2), pages 399-428, March.
  3. Hasan, Iftekhar & Dwyer, Gerald P, Jr, 1994. "Bank Runs in the Free Banking Period," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(2), pages 271-88, May.
  4. Lin, Wen-Ling & Engle, Robert F & Ito, Takatoshi, 1994. "Do Bulls and Bears Move across Borders? International Transmission of Stock Returns and Volatility," Review of Financial Studies, Society for Financial Studies, vol. 7(3), pages 507-38.
  5. Hartmann, P. & Straetmans, S. & De Vries, C.G., 2001. "Asset Market Linkages in Crisis Periods," Papers 71, Quebec a Montreal - Recherche en gestion.
  6. François Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04.
  7. Reint Gropp & Jukka M. Vesala & Giuseppe Vulpes, 2004. "Market indicators, bank fragility, and indirect market discipline," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 53-62.
  8. Mervyn A. King & Sushil Wadhwani, 1989. "Transmission of Volatility Between Stock Markets," NBER Working Papers 2910, National Bureau of Economic Research, Inc.
  9. Kee-Hong Bae & G. Andrew Karolyi & Rene M. Stulz, 2000. "A New Approach to Measuring Financial Contagion," NBER Working Papers 7913, National Bureau of Economic Research, Inc.
  10. Grossman Richard S., 1993. "The Macroeconomic Consequences of Bank Failures under the National Banking System," Explorations in Economic History, Elsevier, vol. 30(3), pages 294-320, July.
  11. Bongini, Paola & Laeven, Luc & Majnoni, Giovanni, 2002. "How good is the market at assessing bank fragility? A horse race between different indicators," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1011-1028, May.
  12. de Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic Risk: A Survey," CEPR Discussion Papers 2634, C.E.P.R. Discussion Papers.
  13. Corsetti, Giancarlo & Pericoli, Marcello & Sbracia, Massimo, 2005. "'Some contagion, some interdependence': More pitfalls in tests of financial contagion," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1177-1199, December.
  14. Alessandro Rebucci, 2003. "Measuring Contagion With A Bayesian Time-Varying Coefficient Model," Working Papers. Serie AD 2003-20, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  15. Ang, Andrew & Chen, Joseph, 2002. "Asymmetric correlations of equity portfolios," Journal of Financial Economics, Elsevier, vol. 63(3), pages 443-494, March.
  16. Marcus, Alan J & Shaked, Israel, 1984. "The Valuation of FDIC Deposit Insurance Using Option-pricing Estimates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(4), pages 446-60, November.
  17. Brian H. Boyer & Michael S. Gibson & Mico Loretan, 1997. "Pitfalls in tests for changes in correlations," International Finance Discussion Papers 597, Board of Governors of the Federal Reserve System (U.S.).
  18. Charles W. Calomiris & Joseph R. Mason, 2001. "Causes of U.S. bank distress during the depression," Proceedings 714, Federal Reserve Bank of Chicago.
  19. Gay, Gerald D & Timme, Stephen G & Yung, Kenneth, 1991. "Bank Failure and Contagion Effects: Evidence from Hong Kong," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 14(2), pages 155-65, Summer.
  20. Goh, Jeremy C & Ederington, Louis H, 1993. " Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?," Journal of Finance, American Finance Association, vol. 48(5), pages 2001-08, December.
  21. Paul Bennett & Jeanette Kelleher, 1988. "The international transmission of stock prices disruption in October 1987," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 17-33.
  22. Ramchand, Latha & Susmel, Raul, 1998. "Volatility and cross correlation across major stock markets," Journal of Empirical Finance, Elsevier, vol. 5(4), pages 397-416, October.
  23. Kristin J. Forbes & Roberto Rigobon, 2002. "No Contagion, Only Interdependence: Measuring Stock Market Comovements," Journal of Finance, American Finance Association, vol. 57(5), pages 2223-2261, October.
  24. Hamao, Yasushi & Masulis, Ronald W & Ng, Victor, 1990. "Correlations in Price Changes and Volatility across International Stock Markets," Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 281-307.
  25. Susmel, Raul & Engle, Robert F., 1994. "Hourly volatility spillovers between international equity markets," Journal of International Money and Finance, Elsevier, vol. 13(1), pages 3-25, February.
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