Debt and financial market contagion

Area of Science:

• Economics
• Financial Markets
• International Finance

Background:

• Financial crises exhibit complex transmission mechanisms across borders.
• Existing models often struggle to fully capture the dynamics of global financial contagion.
• Identifying key drivers of crisis propagation is crucial for economic stability.

Purpose of the Study:

• To empirically investigate the drivers of financial crisis contagion.
• To develop and apply a novel multiple-channel test for financial market contagion.
• To analyze the relative importance of direct linkages versus common characteristics in crisis transmission.

Main Methods:

• Development of a new multiple-channel test for financial market contagion.
• Construction of crisis severity indices for equity markets.
• Application of network analysis to crisis data from 2007-2021.

Main Results:

• The Great Recession was the most pervasive global crisis, followed by the European sovereign debt crisis and COVID-19 pandemic.
• The subprime mortgage crisis showed the least cross-country pervasiveness.
• Similarities in public, private, and external debt characteristics significantly explain financial shock transmission during crises.

Conclusions:

• Debt characteristics are the most critical factor in explaining financial crisis contagion.
• Fiscal deficits are more influential than current account deficits in crisis transmission.
• Stage of economic development is a more significant factor than regional linkages, but less so than debt.