Modelling International Stock Market Contagion Using Copula and Risk Appetite

Forbes and Rigobon (2002) claim there was no contagion among international stock markets duringthe 1997 Asian crisis, with contagion being defined as an increase in dependence. We revisit thisissue using a more robust methodology based on copula. After controlling for heteroskedasticitywith the skewed-t AR-GARCH model, we find clear evidence of contagion using dummy t-copulaand two versions of time-varying t-copula. For the month from October 17, 1997 to November 17,1997, contagion was widespread among the Asian and Europe countries, but not the LatinAmerican ones. Contagion was also confirmed by our world and regional risk appetite indicescompiled from 36 stock market indices and 32 bond market indices. Our risk appetite indices havealso successfully captured five other extreme events in the last decade, including two terroristattacks, corporate scandal in the U.S., LCTM default and the internet bubble burst....