European Equity Market Contagion: An Empirical Application to Ireland's Sovereign Debt Crisis

Abstract

This paper examines the time-varying conditional correlations of daily European equity market returns during the Irish sovereign debt crisis. A dynamic conditional correlation (DCC) multivariate GARCH model is used to estimate to what extent the collapse of Irish equity markets and subsequent troika intervention in Ireland spilled over upon European equity markets during this crisis. During the Irish financial crisis from 2007 to 2010, strong contagion effects are uncovered between Irish equity markets and the investigated European equity markets. The contagion effects are found to ease dramatically in the period after troika intervention in Irish finances. This result supports the use of bailouts and external financial intervention as a mechanism to mitigate and absorb contagion associated with state-specific financial crises and if possible, should be considered as a primary response function in future cases of sovereign debt crisis.