Abstract

The recent Euro area crisis, which has originally been driven mainly by macroeconomic factors, has had a strong impact also on financial markets leading internationally to what is referred as contagion, that is co-movements among asset prices which have been excessive respect to fundamentals. The term "contagion", generally used in contrast to "interdependence", conveys the idea that during financial crisis there might be breaks or anomalies in the international transmission mechanism, arguably reflecting switches across multiple equilibria, market panics unrelated to fundamentals, investors' herding and the like. Although there is still wide disagreement among economists about what contagion is exactly and how it should be tested empirically, a common approach consists of identifying breaks in the international transmission of shocks indirectly, inferring them from a significant rise in the correlation of asset returns across markets and countries. Our study extends on this conventional measures of contagion by directly investigating changes in the existence and the directions of causality among a sample of Euro area countries during the recent Lehman default and sovereign debt crisis. To test for contagion, we apply a three steps Granger causality/VECM methodology on sovereign bond spreads and stock returns as measures of perceived country risk. Results highlight the fact that the causality patterns have changed during the "crisis" periods compared to the pre-crisis "tranquil" periods, thus pointing out the occurrence of contagion phenomenon among Euro area countries during the last two international financial crises.

The authors would like to thank Giovanni Siciliano and Nadia Linciano for their valuable comments. The content of the publication is the sole responsibility of the authors and does not necessarily reflect the view of Consob.