Abstract
This paper examines the time-varying conditional correlations of daily European equity market returns during the Irish sovereign debt crisis. A dynamic conditional correlation (DCC) multivariate GARCH model is used to estimate to what extent the collapse of Irish equity markets and subsequent troika intervention in Ireland spilled over upon European equity markets during this crisis. During the Irish financial crisis from 2007 to 2010, strong contagion effects are uncovered between Irish equity markets and the investigated European equity markets. The contagion effects are found to ease dramatically in the period after troika intervention in Irish finances. This result supports the use of bailouts and external financial intervention as a mechanism to mitigate and absorb contagion associated with state-specific financial crises and if possible, should be considered as a primary response function in future cases of sovereign debt crisis.
Highlights
Financial contagion phenomena have become more pronounced and aggressive in recent years, after the onset of the United States subprime crisis in 2007 that triggered an international financial crisis that rippled throughout banks and financial markets around the world
This research examines the European crisis through the implementation of a threestage Dynamic Conditional Correlation (DCC)-GARCH model to obtain information found in European equity markets related to contagion stemming from the Irish-specific sovereign debt crisis
It focuses on the increase in the strength of the transmission of the Irish sovereign debt crisis between 2007 and 2010, to eleven of the European equity markets
Summary
Financial contagion phenomena have become more pronounced and aggressive in recent years, after the onset of the United States subprime crisis in 2007 that triggered an international financial crisis that rippled throughout banks and financial markets around the world. The high levels of debt were attributed to relaxed financial regulation, low taxation and high public expenditure This research examines the European crisis through the implementation of a threestage Dynamic Conditional Correlation (DCC)-GARCH model to obtain information found in European equity markets related to contagion stemming from the Irish-specific sovereign debt crisis. The model can be used to shed light on underlying questions based on the time-varying effects of correlation within European equity markets, or the effects on equity market correlations during periods of crises, or contagion effects stemming from a particular event.
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