On financial contagion and implied market volatility

Abstract

This paper investigates volatility contagion across U.S. and European stock markets during the Global Financial Crisis (GFC) and the Eurozone Sovereign Debt Crisis (ESDC). Using a sample of international implied volatility indices on daily changes, I explore asymmetric conditional correlation dynamics across stable and crisis periods and across the different phases of both crises. Empirical evidence indicates the existence of contagion in cross-market volatilities. A different pattern of infection is observed across the phases, since the early phase of the GFC and the late period of escalation of the Euro crisis are the most contagious periods. This implies that the initial signal of the two crises has been differently recognized by implied volatility markets. The results provide important implications for the effectiveness of international portfolio diversification and volatility hedging during periods of negative shocks.