Financial Contagion: A Tale of Three Bubbles

Abstract

The primary purpose of the study is to identify and measure the properties of asset bubbles, volatility clustering, and financial contagion during three recent financial market anomalies that originated in the U.S. and Chinese markets. In particular, we focus on the 2000 DotCom Bubble, the 2008 Housing Crisis, and the 2015 Chinese Bubble. We employ three main empirical methods; the LPPL model to identify asset bubbles, the DCC-GARCH model to measure volatility clustering, and the Diebold-Yilmaz volatility spillover index to measure the level of financial contagion. We provide robust evidence that during the DotCom bubble there was very limited spillover between the S&P 500, the Shanghai, and the Shenzhen Composite Indexes. However, there was significantly more spillover effects in the two more recent crises, i.e., the Housing crisis and the 2015 Chinese Bubble. Together, these results highlight the fact that as financial markets have become more globalized, there are greater levels of volatility transmission and correspondingly fewer potential benefits from international diversification.

International Financial System and Capital Markets: A Brief Overview

“…Throughout history, there have been ups and downs in the degree of financial integration between countries and regions, going from high financial integration (globalization) to low, and then back to high again. The benefits of increased financial integration like efficient (re)allocation of capital or risk sharing are many, but so are the dangers of financial contagion and other negative spillovers from an increasingly intertwined world economy (Allen and Gale, 2000;Burks et al, 2021).…”