The international propagation of shocks in international equity markets during the subprime mortgage crisis

We focus on the contagion effects of international financial markets arising from financial crisis. By analyzing a panel of percentage natural logarithm return rate of 12 countries, we qualify the impact of financial contagion in global equity markets from the subprime mortgage crisis. The paper uses adjusted correlation analysis approach and latent factor model to measure the international propagation of common and idiosyncratic shocks respectively. The results show that as the United States is the centre of the subprime mortgage crisis, contagion decreases with the geographical distance from the centre, closer the distance, greater the effect will be, that is, America is the most affected area, followed by Europe, then the Asia region. To put it further, through variance decomposition we compare countries in America and Asia to see the effects and degree of contagion. We find that China and Japan are the least affected countries compared with others and we explain the reason at the end of the paper.