Abstract
The accuracy of contagion prediction has been one of the most widely investigated and challenging problems in economic research. Much effort has been devoted to investigating the key determinant of contagion and enhancing more powerful prediction models. In this study, we aim to improve the prediction of the contagion effect from the US stock market to the international stock markets by utilizing Google Trends as a new leading indicator for predicting contagion. To improve this contagion prediction, the dynamic copula models are used to investigate the structure of dependence between international markets and the US market, before, during, and after the occurrence of the US financial crisis in 2008. We also incorporate the Google Trends data as the exogenous variables in the time-varying copula equation. Thus, the ARMAX process is introduced. To investigate the predictive power of Google Trends, we employ the likelihood ratio test. Our empirical findings support that Google Trends is a significant leading indicator for predicting contagion in seven out of 10 cases: SP-FTSE, SP-TSX, SP-DAX, SP-Nikkei, SP-BVSP, SP-SSEC, and SP-BSESN pairs. Our Google-based models seem to predict particularly well the effect of the US crisis in 2008. In addition, we find that the contribution of Google Trends to contagion prediction varies among the different stock market pairs. This finding leads to our observation that the more volatile the market time-varying correlation, the more useful Google Trends.
Highlights
Contagion effect across countries and stock markets is an important issue concerned by economists, practitioners, and investors
We find that the estimated ARCH coefficient (α) and GARCH coefficient (β) are mostly significant at the 5% level for all markets’ returns, signifying the presence of clustering volatility phenomenon in all stock returns during pre-crisis, crisis, and post-crisis periods
All other assessed abnormal GI (AGI) appear to have been relatively less exposed to the effects of the contagion. These results indicate that the contagion between the US and some international markets may be predicted by either crisis-keywords searched by US people or crisis-keywords searched by local people
Summary
Contagion effect across countries and stock markets is an important issue concerned by economists, practitioners, and investors. In the recent few decades, the world economy has experienced various financial and economic crises, for example, savings and loans crisis (the 1980s), stock market crash (1987), Tequila crisis (1994), Asian crisis (1997), and the latest global financial crisis (2007). These incidents have generated a tremendous negative effect on the stock markets in many countries. Hwang and Kim [2] revealed that this crisis adversely affected the banking sector, stock market, and credit market, which subsequently caused the economic recession, an increase in the unemployment rate, and a decrease in international trade. As the global economies are interdependent, contagion may occur in different asset markets and even different stock markets
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