News-based economic policy uncertainty and financial contagion: An international evidence

Abstract

In this paper, we examine the relative importance of economic policy uncertainty as a potential source intensifying market integration/contagion for domestic stock markets of 31 countries. Our data spans the period June 2001-October 2021 that encompasses several episodes of economic and financial turmoil. We use the multifactor asset pricing model of Bekaert et al. (2005) with a two-factor setting which are the U.S. market return and the regional equity portfolio return to reflect the local, regional and global risk sources. Our findings show that economic policy uncertainty has an important role in intensifying spillover effects among regional European markets. Results also show an increased interdependency between used Asia Pacific and Latin American markets and the U.S. market during periods of high U.S. and global uncertainties induced by the increased portion of return shock variance explained by the U.S. factor. Considering contagion, we fail to provide evidence of additional unconditional correlation of returns with the United States and the region during these same periods of time, which suggests that the influence is rather induced by fundamentals. The implications of this study will be of interest to both practitioners and market regulators to better adopt proactive awareness regarding stock market behavior.