Economics, Econometrics and Finance
4 years ago

Explosive market shocks reveal hidden contagion risks in Eurozone

arXiv (Cornell University)
An empirical test for Eurozone contagion using an asset-pricing model with heavy-tailed stochastic volatility
Nicholas G. Polson, James G. Scott

Paper Summary

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The study tested for financial contagion in European markets from 2008-2011. Traditional models couldn't explain sudden market volatility spikes and directional biases in country-level returns. The new model showed that volatility shocks are heavy-tailed and correlated, affecting returns. Significant contagion was found during EU crisis periods in 2010 and 2011, with high sensitivity to volatility shocks predicting financial crises. The correlation between volatility and returns changed over time, reflecting major events in the periods analyzed.