Contagion during the financial crisis of 2007-2008

Abstract

The global financial crisis in recent times has created a deep appreciation for the strong connectivity between the world economies. First regarded as a domestic shock, the subprime mortgage crisis in the United States ultimately created intense ripple effects across the borders, leading to the understanding that there are mechanisms in place between economies that can transmit a domestic crisis internationally. Loss of confidence in securitized products based on the real assets market led to a crippling breakdown in the financial market, creating economic and financial instability. Having differentiated the term contagion, with that of spillover and interdependence, an attempt was made to identify the contagious effects of the crisis in the U.S. on financial markets of the G8 countries and Norway. Both stock markets and government bond markets in the economies show comovement during the financial crisis of 2007-2008, with volatility in asset returns increasing. Tests for contagion using cross-market correlation showed that while contagious effects are visible with regard to stock markets, it was less evident in the government bonds markets.