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There is no unanimity in the literature regarding the causes of increasing cross–market correlations in crisis periods. This effect is often justified by the authors as a consequence of contagion, but the evidence is that contagion can be confused with the integration effect since both have a tendency to increase correlations among markets, especially during down-market periods. The main goal of this paper is to examine the effect of increasing cross–market correlations during the 2007–2009 global financial crisis on the largest European stock markets (i.e. the U.K., France and Germany), in the context of the influence of the 2007 U.S. subprime crisis. The crisis periods are formally established based on the statistical method of dividing market states into bullish and bearish markets. The evaluation of contagion is carried out by applying both standard contemporaneous cross–market correlations and volatility– adjusted cross-correlations (Forbes, Rigobon 2002). The results are consistent with the literature and confirm that heteroskedasticity in market returns biases tests for contagion based on correlation. Moreover, an integration test is performed using the Larntz–Perlman (1985) procedure for testing the equality of correlation matrices computed over nonoverlapping subsamples: the pre–crisis and crisis periods in the group of investigated markets. No reason was found to reject the research hypothesis of no integration effect during the recent global crisis. The study might be viewed as a contribution to the debate concerning the causes of increasing cross–market correlations during periods of turmoil.

Increasing cross-market correlations during the 2007-2009 global financial crisis: contagion or integration effects?