The Eurozone crisis and its contagion effects on the European stock markets

Abstract

Purpose

This paper aims to examine the contagion effects of Greece, Ireland, Portugal, Spain and Italy (GIPSI) and US stock markets on seven Eurozone and six non-Eurozone stock markets.

Design/methodology/approach

In this paper, a dynamic conditional correlation (DCC) model popularly known as DCC-GARCH (Generalized Autoregressive Conditional Heteroscedasticity) model given by Engle (2002) is applied to estimate the DCCs across sample markets.

Findings

Analyzing the Eurozone crisis period, the empirical results suggest that among GIPSI stock markets, Spain, Italy, Portugal and Ireland appear to be most contagious for Eurozone and non-Eurozone markets. The study finds that France, Belgium, Austria and Germany in Eurozone and UK, Sweden and Denmark in non-Eurozone are strongly hit by the contagion shock.

Practical implications

The findings of the study have significant implications for the concerned regulatory authorities, as it may provide an important direction for further policy research with regard to financial integration in the European Union (EU). From global investors’ perspective, the EU-based diversification strategies seem to be inefficient especially during Eurozone crisis.

Originality/value

To the best of the authors’ knowledge, this is the first study that examines the issue of financial contagion of Eurozone crisis for a large basket of stock markets of European countries comprising seven Eurozone and six non-Eurozone markets for the period 2009-2012. The study uses the Markov regime switching model to identify crisis period and utilizes the DCC estimates of DCC-GARCH to examine the patterns of financial contagion. The finding of this study is quite interesting and is different in several ways than existing studies in the literature.

Citation

Ahmad, W., Bhanumurthy, N.R. and Sehgal, S. (2014), "The Eurozone crisis and its contagion effects on the European stock markets", Studies in Economics and Finance, Vol. 31 No. 3, pp. 325-352. https://doi.org/10.1108/SEF-01-2014-0001