key: cord-0875140-kx1r30kn
authors: Chopra, Monika; Mehta, Chhavi
title: Is the COVID-19 pandemic more contagious for the Asian stock markets? A comparison with the Asian financial, the US subprime and the Eurozone debt crisis
date: 2022-01-19
journal: J Asian Econ
DOI: 10.1016/j.asieco.2022.101450
sha: c288c34aeb286afd5c754292815ca2bae8bb22cb
doc_id: 875140
cord_uid: kx1r30kn

The ongoing COVID-19 pandemic has sent shock waves across the global stock markets. Several financial crises in the past too have had a global impact with their reach extending beyond the country of origin. The current study compares the contagion effect of four such crises viz. the Asian financial crisis, the US subprime crisis, the Eurozone debt crisis, and the currently ongoing Covid-19 crisis on Asian stock markets to understand which of these has had the most severe impact. It finds that among all the four crises, the US subprime crisis has been the most contagious for the Asian stock markets. The study also highlights the difference between severities of a liquidity crisis versus a real crisis and identifies the markets that remained insulated from all these crises, a finding which will be useful for portfolio managers in devising their asset allocation.

first true global contagion then broke out with the crashing of the financial markets in the United States and Europe as well. Several researchers have examined the potential reasons for the occurrence and spread of this contagion across geographies (Baig & Goldfajin 1998; Kuper & Lestano, 2007; Allen & Gale, 1999; Forbes & Rigobon, 2002; Chinn, 1997; Corsetti et al., 1999; Goldstein, 1998; Chowdhary & Goyal, 2000; Jang & Sul, 2002) . These studies suggest that the Asian crisis resulted in financial market instability, which caused market participants across various countries to move together. This movement intensified the relationship among the financial markets during the crisis, resulting in contagion. Chancharoenchai & Dibooglu (2006) evaluated contagion effect of the Asian crisis in various Southeast Asian stock markets namely Thailand, Philippines, Indonesia, Malaysia, Korea and Taiwan. Their study observed that the crisis began in Thailand and spread through the markets of Southeast Asia. Khan & Park (2009) revisited the contagion in five Asian countries viz. Thailand, Malaysia, Indonesia, Korea, and Philippines, and attributed it to the herding behavior of investors in the Asian markets, based on the belief that if Thailand is facing trouble, other Asian markets will follow suit.

The US subprime crisis can be attributed to the burst of the U.S. mortgage bubble in 2007. It was marked by the bankruptcy of Lehman Brothers, the country's biggest bankruptcy till date, and had global ramifications. Followed by this, the Eurozone sovereign debt crisis began after the government of Greece declared that its public deficit had hit 12.7 per cent of the domestic GDP, four times the permitted cap. Various academics interested in financial contagion have assessed these two crises because of their widespread effects.

Among the studies on contagion caused by the US subprime crisis, Longstaff (2010) established the financial contagion of 2008 and attributed its spread to liquidity and risk-premium channels across major countries of the world. Bekaert et al. (2011) used an asset-pricing framework to find the existence of a very small but a statistically significant transmission of the subprime crisis to country-industry equity portfolios in 55 countries. In addition to the contagion effects from US markets, the study also found contagion effects from domestic equity markets to individual domestic equity portfolios. Gallegati (2012) used a wavelet-based approach to test whether contagion occurred during the US subprime crisis of 2007. The study found that all stock markets have been affected by the US subprime crisis and that Brazil and Japan are the only J o u r n a l P r e -p r o o f countries in which contagion is observed at all scales. Their results provide evidence of international contagion effects from the USA during the subprime crisis, and indicate that these contagion effects do not display their influence uniformly across scales, except for Japan and Brazil. Chudik and Fratzscher (2012) demonstrated that investors had a flight-to-safety behavior during US subprime crisis due to which financial capital moved from emerging market economies to bond markets in the USA and other advanced economies. Neaime (2012) studied the contagion related global and regional financial linkages between MENA stock markets and the more developed financial markets, as well as on the intra-regional financial linkages between MENA countries' financial markets. Horta et al. (2014 Horta et al. ( & 2016 found that financial markets in Canada, Japan, as well as European markets viz. Belgium, France, Netherlands and UK displayed significant signs of contagion while those in Germany and the Portugal showed mere interdependence. Dimitriou et al. (2013) found significant contagion among the BRIC markets with the USA during different phases of the subprime crisis, which they attributed to their common trade and financial characteristics. Wang (2014) evaluated the contagion impact on six major East Asian stock markets namely, China, Hong Kong, Taiwan, Singapore, South Korean and Japan, due to the subprime crisis and found a strong contagion among the USA, Japanese however, the degree to which financial markets respond to such shocks varies by market, depending on the level of integration with the global economy. Kim et al. (2015) found that the US subprime crisis had a major spillover impact on five Asian countries namely, Indonesia, Korea, Philippines, Thailand and Taiwan, and that this impact was stronger in the foreign exchange than the equity markets. Mohti et al (2019) studied the impact of the US financial and the Eurozone debt crises on a set of 18 frontier stock markets. Using the USA and Greece as benchmark countries, they found a weak evidence of contagion during the Eurozone debt crisis to prove that the US subprime crisis created a greater turmoil on the frontier markets. Kaou, Ku & Nieh (2019) studied asymmetry in contagion effects of US subprime crisis between the U.S. S&P 500 Index and 23 markets in Asia, Europe, and America. They found that the subprime crisis determined the degree of contagion, depending on the financial linkage to the U.S. market, which also demonstrated the differences in the causes and influence between the subprime crisis J o u r n a l P r e -p r o o f and other financial crises in emerging markets. Tilfani, Ferreira & Boukfaoui (2021) measure the cross correlation between between the USA and other eight stock markets (the remainder of the G7 plus China and Russia) to study the contagion effect during the US sub-prime crisis. They found a decrease in correlation levels of other stock markets with US stock market before the crisis and an increase during the crisis, pointing out to the presence of contagion effect.

Missio & Watzka (2011) studied the contagion effect in Euro area through the correlation structure of Greek, Portuguese, Spanish, Italian, Dutch, Belgian and Austrian bond yield spreads over the German yield. The findings of their study point towards the presence of contagious effects spreading from Greece mainly to Portugal, Spain, Italy and Belgium. The study also found that that the announcements of negative rating for Greece have generated contagious effects to Portugal and Spain. Grammatikos and Vermeulen (2012) examined the contagion effect of Eurozone debt crisis on fifteen EMU countries and found strong evidence of the same.

Samitas & Tsakalos (2013) studied eight European markets viz. the UK, France, Germany and the "PIIGS" (Portugal, Italy, Ireland, Greece and Spain) to decipher the Eurozone debt crisis.

They found that the Greek crisis seems to have had less of an effect on the correlation between the Greek stock market and the seven indices studied. Ahmad, Bhanumurthy & Sehgal (2014) assessed the contagion effects of Eurozone crisis on stock markets of seven Eurozone and six non-Eurozone countries. The study observed that among the Eurozone countries Austria, Belgium France and Germany and among the non-Eurozone Denmark, Sweden and UK were the most severely affected by the contagion shock. Thus the EU-based diversification strategies were not effective during Eurozone crisis. Aizenmann et al. (2016) evaluated the impact of the eurozone debt crisis on the bond market and stock market of the developing countries and found mixed results regarding the presence and magnitude of financial contagion. They concluded that the eurozone debt crisis largely affected Europe. Samarakoon (2017) investigated the contagion effect of the Eurozone debt crisis on the fifty-two stock markets around the world and found that the Asian stock markets display no signs of contagion from the Eurozone crisis. Kosmidou et al.

(2018) further studied the Eurozone debt crisis and show that policy announcements from the EU, ECB, and IMF had an effect on the transmission of banking sector shocks to the stock market during this crisis. Furthermore, they found that national governments' policy responses J o u r n a l P r e -p r o o f seemed to play an important role in the spread of the crisis. Anastasopoulos (2018) evaluated the contagion effect of Greek debt crisis on the stock markets of European countries. The study found that the crisis was contagious, although the contagion effects were not persistent.

The World Health Organization declared COVID-19 to be a pandemic on March 11, 2020.

Initially, the bulk of COVID-19 confirmed cases and deaths came from China and the G7 countries (WHO, 2020a during Covid-19 significantly increased equity market volatility across 67 countries around the world. Ashraf (2020) examined stock market reaction to the COVID-19 pandemic using regularly reported COVID-19 cases and deaths, as well as stock market returns data from 64 countries. The study found that the negative market reaction was strongest during the early days of reported cases and this reaction differed over time depending on the stage of the outbreak. Banerjee (2021) looked into the possibility of financial contagion between China and its major trading partners during the pandemic. The study showed substantial financial contagion in most developed and emerging markets with significant trading relationships with China. Malik et al.

(2020) measured the contagion during COVID-19 via volatility spillovers between BRIC countries and the USA. They found that as compared to Russia and India, the USA, China, and Brazil had the highest own volatility spillovers while Russia was the least vulnerable to external shocks. The United States and Russia had the greatest and most long-term spillover impact. countries during COVID-19 based on financial and non-financial firms. Their findings revealed that correlations between the stock returns of these firms across G7 have increased significantly and this increase is much higher for financial firms during the period of COVID-19 outbreak, demonstrating the critical position they play in financial contagion transmittance. Okorie & Linb (2020) investigated the fractal contagion effect of the COVID-19 crisis on the stock markets of 32 countries. The results confirmed the existence of a significant contagion impact in the stock markets; however, the impact is short-lived. These effects can be seen in both stock markets and volatility. Fu Liy & Lee (2021) found the impact of the COVID-19 pandemic on the stock markets of 15 countries selected from Asia, Europe, Latin America, and North America. Using extremal dependence tests of contagion, the study found that contagion effects were widespread to global equity markets in four regions. Latin America and North America are highly exposed to contagion risks, followed by Europe, with Asia being least vulnerable. Out of these, Latin America with severe epidemic had a stronger contagion effect. Iwanicz-Drozdowska et al.

(2021) investigated the impact of a wide range of economic as well as non-economic events on stock market spillover effects across 16 major developed and emerging countries over the 2000-2020 period. They found the COVID-19 pandemic to be the most widespread sources of noneconomic contagion and prudential measure taken by governments to be the most influential source of economic contagion.

The COVID-19 crisis is a recent and ongoing phenomenon, which offers the scope for further understanding its contagion effect. The review of literature discussed above shows that existing research on contagion in Asian countries has mostly focused on the Asian financial and the US subprime crises, with a few studies on the Eurozone debt crisis. However, we did not find a comparative analysis of the severity of all the past crises, especially in relation to the COVID-19 pandemic. Such an analysis is required in order to identify which crisis can serve as an ideal laboratory for studying the best combination of the Asian stock markets for a portfolio diversification strategy, given their relationships during these crises.

Our study fills this gap by covering the episodes of four financial crises, including the COVID-19 pandemic, to understand whether this pandemic has been the most contagious for the Asian stock markets among all the crises. Additionally, this comparison gives a better insight into whether the policy responses from regulators across countries, towards any crisis, have been J o u r n a l P r e -p r o o f useful in preventing contagion during subsequent crises, enabling international diversification to be useful when it is needed the most.

We investigate the contagion effect for emerging as well as developed stock markets of Asia during the Asian financial crisis, the US subprime crisis, the Eurozone debt crisis, and the ongoing COVID-19 pandemic. Accordingly, we compute Dynamic Correlation Coefficients (DCC) coefficients between the crisis-originating country (i.e. the epicenter of the crisis) and each individual Asian market. We consider thirteen Asian countries (as classified under emerging and developed markets by Morgan and Stanley Capital International -MSCI). Table 1 shows the emerging and developed Asian markets taken for the study, and the country taken as epicenter of each crisis. J o u r n a l P r e -p r o o f Based on our own analysis taking US subprime and European crisis periods as benchmarks

We use Engle"s (2002) and Banerjee (2021) have used the measure to examine contagion behavior in financial markets during the crises cycles.

There are two steps in the estimation of the DCC-GARCH model. The first step estimates the univariate GARCH model and the second, the conditional correlations that vary across time. The multivariate DCC-GARCH model can be defined as:

Here is the vector of past observations. is the multivariate conditional variance and = ( is the vector of conditional returns. is the vector of standardized residuals and is an N × N symmetric dynamic correlations matrix. is a diagonal matrix of conditional standard deviation for return series obtained from estimating the univariate GARCH model with √ on the i th diagonal and i = 1,2,…..n.

The model defines DCC specification as follows:

Here, (

the unconditional correlations of δ it , δ jt , and and are non-negative scalar parameters that satisfy the condition = [q* ii,t ] = √ . Here, √ is a diagonal matrix with the square root of the i th diagonal element of on its i th diagonal position. Therefore, for a pair of markets i and j, their conditional correlation at time t can be defined as:

Where is the element on the i th line and j th column of the matrix . The quasi-maximum likelihood method (QMLE) (Bollerslev et al. (1992) is used to calculate the parameters. The loglikelihood of the estimators, under the Gaussian assumption is stated below:

Where n, T and are the number of equations, the number of observations, and the vector of parameters to be derived, respectively.

We use t-tests to find if there is any evidence of contagion. For this, we examine whether DCC coefficients increase significantly during the crisis period as compared to the pre-crisis times.

These statistics are for one-sided t-tests (Forbes & Rigobon, 2002) . Following Forbes & Rigobon (2002) and Celik (2012), we define the null hypothesis as:

Where and are the dynamic conditional correlation coefficients means of the sample during the crisis and pre-crisis period.

Given the sample sizes of , , population variances of  2 pre-crisis and  2 post-crisis and dynamic conditional correlation coefficients estimated via DCC as ̅ and ̅ ; the t-statistic is calculated as:

Here,

The degree of freedom is estimated as follows:

T-test results indicate the presence of contagion if the t-statistic is more than the critical value.

However, if it is less than or equal to the critical value, no contagion has occurred.

Tables 4, 5, 6 and 7 present the descriptive statistics of the stock market during the pre-crisis and J o u r n a l P r e -p r o o f I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 China - I  II  III  IV  I  II  III  IV  III  IV  I  II   1995  1996  1997 I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 Philippines -.10 -.05

.00

.05

.10

.15

.20

.25

. 30   I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 Australia I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 Hong Kong I  II  III  IV  I  II  III  IV  III  IV  I  II 1995 1996 1997 1998 Japan J o u r n a l P r e -p r o o f I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008  2009 Australia -.08 -.04

.00

.04

.08

.12

.16

.20

.24

. 28   I II III IV I II III IV I II III IV I II III IV I II III IV   2005 I II III IV I II III IV I II III IV I II III IV I II III IV   2005 I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008  2009 Korea -.08 -.04

.00

.04

.08

.12

.16

.20

.24

. 28   I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008 I II III IV I II III IV I II III IV I II III IV I II III IV   2005 I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008 I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008 I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008 I II III IV I II III IV I II III IV I II III IV I II III IV   2005  2006  2007  2008  2009 Thailand J o u r n a l P r e -p r o o f I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 .4

.5

.6

.7

. 8   I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005  2006  2007 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005  2006  2007 I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005  2006  2007 2009  2010  2011  2012 New Zealand .24

.28

.32

.36

.40

. 44   I II III IV I II III IV I II III IV I II III IV I II III IV I II   2005  2006  2007 2009  2010  2011  2012 Singapore J o u r n a l P r e -p r o o f I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018  2019  2020 .20

.24

.28

. 32   I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018 .4

.5

.6

.7

. 8   I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018  2019  2020  2021 Korea -.08 -.04

.00

.04

.08

.12

.16

.20

.24

.28

. 32   I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018 2019 2020 2021 I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018 I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018 I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018  2019  2020  2021 Hong I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018  2019  2020 I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018  2019  2020  2021 New I  II  III  IV  I  II  III  IV  I  II  III  IV  I  II   2018  2019  2020  2021 Singapore J o u r n a l P r e -p r o o f Tables 8-15 provide the unconditional correlations and dynamic conditional correlations between the crisis originating market and the rest of the markets in the sample as well as the results of ttest. In the case of Asian crisis (Table 8) The results of the t-test (Table 9) indicate that there is a significant increase in the correlation coefficient for India, Indonesia, South Korea, Taiwan and Australia during the crisis period as compared to the pre-crisis period. Hence, we reject the null hypothesis indicating the presence of contagion from Thailand to these five countries. For the rest of the countries, viz. China, Malaysia, Philippines, Hong Kong and Japan, we cannot reject the null hypothesis i.e. the mean of DCC coefficients of the crisis are greater than or equal to the pre-crisis eras. This indicates the absence of the contagion effect from Thailand towards these countries during the Asian crisis. J o u r n a l P r e -p r o o f This shows that the contagion caused by the Eurozone debt crisis spread less than the Asian crisis and the US subprime crisis. J o u r n a l P r e -p r o o f J o u r n a l P r e -p r o o f J o u r n a l P r e -p r o o f

Stock market comovements between countries can be the result of interdependence or contagion.

Any comovement caused due to asset trading, bilateral trade or technological factors is interdependence (Forbes & Rigobon, 2002) ; on the other hand, the comovement due to flight-toquality and liquidity (Longstaff, 2004) or investor sentiments regarding possible impact on their country"s fundamentals is contagion. This type of contagion is also known as a herding contagion (Khan & Park, 2009 ). The current paper brings out and compares the presence of herding contagion in stock markets during four major financial crises viz. Asian crisis, the US subprime crisis, the Eurozone debt crisis and the COVID-19 pandemic. Our study finds that contagion was the most acute during the US subprime crisis among all.

All the four crises under study spread due to flight-to-quality. At the time of the Asian crisis, there was little role played by Thailand in bilateral trade and competition with other Asian countries. The devaluation of the Thai Baht was perceived as a wake-up call by investors in other Asian countries and they expected similar economic weakness in their countries as well. Due to this expected economic and financial market instability, market participants moved together across a range of countries, transmitting the shocks and resulting in contagion (Baig & Goldfajn, 1998) . Similarly, during the subprime crisis, the shocks in the asset-backed securities (ABS) markets acted as a predictor for the decline in equity markets (Khan and Park, 2009 ). The crisis that primarily occurred due to exposure of banks to packaged subprime loans led to bank failures in the USA and Europe, ultimately resulting in reductions in values of stocks across the globe.

The Eurozone crisis was the result of the balance-of-payments crisis and it worsened due to the inability of EU nations to devalue their currency. In response to this crisis, several stock markets across the world declined. The COVID-19 pandemic put the world in a virtual lockdown leading to a projection of unparalleled geo-economic challenges by financial economists. This resulted in a high implied volatility in equity markets due to flight-to-safety by investors.

The conclusion we draw from our results is that the subprime crisis has been the most contagious for the Asian stock markets, directly affecting multiple channels of financing and liquidity (Allen & Gale, 1999; Brunnermeier & Pedersen, 2009) , and thereby, converting a liquidity contagion to a stock market contagion. Additionally, the impact of this crisis was more severe than the Asian crisis as there was a greater degree of integration of Asian stock markets with the global stock markets, especially the USA in 2007, as compared to the era of 1997 (Cyn-Young J o u r n a l P r e -p r o o f 2013). As a result, the flight-to-quality could have become more intense during the US subprime crisis as compared to the Asian crisis. The Eurozone debt crisis had the weakest impact on the Asian stock markets, spreading only in those regions which were under a significant economic influence of the euro (Mohti et al., 2019). In fact, the results imply a negative contagion and stock market decoupling during this crisis (Samarakoon, 2017) . The COVID-19 crisis originated as a health crisis and affected the real sector in terms of demand and supply mismatch. The pandemic came in waves across different countries and economic activity kept rising in each country as it eased its lockdown conditions. Hence, it did not get priced into the stock markets.

Companies learnt to operate under lockdown and were able to manage profitability by cutting down costs. Hence, the impact of COVID-19 pandemic was less contagious for stock markets compared to the longer impact of the liquidity crisis caused by subprime.

The contagion study in the current paper has several implications for both policymakers and investors. The recurrence of contagion shows that policymakers need to strengthen the fundamentals, such as reduction of information asymmetry if they want markets to rebound from repeated external shocks. If markets are depreciating as a result of panic, the first priority of policymakers should be to calm market sentiments. Learnings from past mistakes and experiences must be used to improve the design of institutions, policies, and market laws, thus reducing the frequency and severity of financial crises. A comparative view of contagions can give policymakers and regulators an insight into devising multifarious approaches to prevent events of varied economic causes and protect their home economies. These findings may also be useful to foreign investors to understand which stock markets can be used as prospective destinations for diversification, given that they have been least affected during any of the four crises. International investors can understand how their portfolio allocation and rebalancing actions can spread the crisis to other markets, which makes following a herding approach risky.

Overall, the paper offers a new perspective on varying degrees of stock market linkages in the form of contagion across crises of different economic significance. The research on COVID-19 is still new and evolving, and more studies on the contagious effects of COVID-19 are warranted given that the crisis is still ongoing. It is only when the pandemic converts into an epidemic and data for longer periods is available, we can conclude about its severity versus other crises. The current study can also be extended to non-Asian markets. This would enable a comparative analysis of markets worldwide, which would further strengthen our findings.

J o u r n a l P r e -p r o o f

Developing countries" financial vulnerability to the eurozone crisis: an event study of equity and bond markets

Financial contagion during COVID-19 crisis

Death and contagious infectious diseases: Impact of the covid-19 virus on stock market returns