Bad Bad Contagion

Bad contagion, the downside component of contagion in international stock markets, has negative implications for financial stability. I propose a measure for the occurrence and severity of global contagion that combines the factor-model approach in Bekaert et al. (2005) with the model-free or co-exceedance approach in Bae et al. (2003). Contagion is measured as the proportion of international stock markets that simultaneously experience unexpected returns beyond a certain threshold. I decompose contagion into its downside or bad component (the co-exceedance of low returns) and its upside or good component (the co-exceedance of high returns). I find that episodes of bad contagion are followed by a significant drop in country-level stock index prices and by a deterioration of financial stability indicators, especially for more open economies.