THE CONTAGION EFFECT IN EUROPE: A DCC GARH APPROACH

Abstract

This research analyses the co-movements between sovereign debt markets, and the stock markets of Germany, Portugal, and Greece, in the period 2009:10 – 2015:07. It aims to provide answers to two questions, namely, whether: i) Was there contagion between bond markets and the Eurozone stock markets? ii) Did the financial sector show contagion? The study used GARCH-DCC econometric models, with the purpose of estimating the dynamic correlation between the markets, using daily data of 10-year OT yields for Greece and Portugal, as well as price indices for Portugal (PSI-20, PSI Financial), and Germany (DAX-30 and DAX Financial). In addition, we also evaluate the variation of the correlation in each of the identified crisis periods against a reference period (pre-crisis). The results suggest contagion from the Greek sovereign debt market to the Portuguese and German stock markets. We found that the Portuguese debt market influenced the German stock market, in a market and financial sector context. In conclusion, it is assumed that the results reveal some understanding of the behaviour of investors under extreme market conditions and contribute to the understanding of the connection between sovereign risk and financial sector risk by market agents, including regulators and policy-makers, who seek to ensure the stability of the international financial system, of which the stock markets are a part of.