Deciphering financial contagion in the euro area during the crisis

Abstract

Abstract Financial market interdependence has been at the epicenter of the crisis in the euro area. This paper tests for the existence of financial contagion during this crisis, defined as the international transmission of country-specific shocks beyond the normal channels of financial interdependence. Since contagion relates purely to country-specific shocks, we combine the standard contagion test of Favero and Giavazzi (2002) with a narrative approach to separate out global and euro area shocks from country-specific shocks. Financial contagion has been widespread during the crisis in the euro area. Three quarters of country-specific shocks are contagious over the whole sample period. But the proportion of contagious country-specific shocks has fallen markedly after the “whatever it takes” announcement in July 2012.