US Cold, Worldwide Pneumonia: American FAMA French Factors Drive Contagion

Abstract

The main contribution of this paper is to show that the American Fama French factors, as proxy for the US stochastic discount factor, drive not only Emerging Markets (EM) contagion, but also the the co-movement increase of EM sovereign debt spreads and US corporate spreads. For the 1998-2006 period the American Fama French factors are signiiB01cant in order to explain EM sovereign debt spreads (EMBI ), an increase in the factors decrease EM spreads. What is more, using a panel error correction model, I disentangle the long and short-run relationship between the EM spreads and the American Fama French factors, controlling both for the US government rate and the US market volatility. The Fama French factors remain highly signiiB01cant. Moreover, I show that in order for EM contagion to exist, there must be an increase in volatility of the M KT , S M B and H M L factors. High volatility in American Fama French factors is a necessary but not suiB03cient condition for EM contagion to exist. I extend the analysis to EM stock markets and show that the Fama French factors remain signiiB01cant, which can also be associated to contagion in stock markets.