A New Test of Financial Contagion with Application to the US Banking Sector

Abstract

A new test for financial market contagion based on increases in extremal dependence (co-kurtosis and co-volatility) is developed to identify the propagation mechanism of shocks across international financial markets. This new approach is applied to test for contagion in equity markets and banking sectors following the global financial crisis of 2008-2009. The results of the tests show significant contagion effects are widespread from the US banking sector to global equity markets and banking sectors. The extremal dependence tests capture more extreme co-movements than the asymmetric dependence tests in extreme events.