Volatility and Contagion effects originating from the financial sector: An analysis of economic sectors in two different stock market downturns

Abstract: The essay applies the methodology put forward in Baur (2003) with some modifications and extensions in order to investigate on contagion and spillover effects originating from the financial sector in European and U.S. equity markets during the crisis following the “dot-com” bubble in 2000-2003 and the financial crisis of 2007-2009. A clear distinction between spillover and contagion effects is drawn and the first as well as the second moment is investigated. An EGARCH approach including a parameter to capture the leverage effect is applied to model the conditional variance. Mean contagion is found to be negative in the U.S. and mostly positive in Europe during the financial crisis which does not provide convincing evidence for the contagion hypothesis, rather the opposite. The more central role the financial sector plays during the financial crisis is clearly reflected in terms of positive volatility contagion in most non-financial sectors. We can conclude that the turbulences in the financial sector encroached partly upon non-financial sectors expressed through positive volatility contagion. Volatility contagion is consistently significant and positive in both the U.S. and Europe for the technology, industrials, and health care sector. However, the approach taken appears not suitable to clearly distinguish between supply-side and demand-side effects.