Developed Market Crises and Developed-Emerging Return Comovements

Abstract

This paper examines how stock market return comovements between developed and emerging markets as a whole vary with developed market uncertainty during 2001-2006 when major crises, such as 9/11 and a series of accounting scandals, originated in developed markets. I find a significantly negative relation between developed market uncertainty and future developed-emerging return comovements. The future developed-to-emerging return linkage, beta, decreases by around 62% when the average developed market uncertainty increases from one standard deviation below its mean to two standard deviation above its mean. The future developed-emerging return correlation also decreases in a similar way. In contrast, the future comovements between developed markets rise with developed market uncertainty in the same period. Several potential contagion explanations that feature investors' cross-country trading and/or shocks to country-specific factors suggest that during contagion crises comovements should be able to either increase or decrease excessively. My findings provide the first evidence that cross-country comovments can decrease during volatile periods and therefore provide support for these contagion explanations. The findings reveal a new, more comprehensive view of contagion effects and have important implications for understanding contagion.