Extreme Returns in the European financial crisis

Published date01 September 2017
Date01 September 2017
Extreme Returns in the European
nancial crisis
Andreas Chouliaras
ICMA Centre, Henley Business School, University of Reading, Henley Business School, Whiteknights,
Reading RG6 6BA
E-mail: a.chouliaras@icmacentre.ac.uk
Theoharry Grammatikos
Luxembourg School of Finance, University of Luxembourg, 4, rue Albert Borschette L-1246
E-mail: theoharry.grammatikos@uni.lu
We examine the transmission of nancial shocks among the euro-periphery
(Portugal, Ireland, Italy, Greece, Spain), the euro-core (Germany, France, the
Netherlands, Finland, Belgium), and the major European Union (but not euro)
countries (Sweden, the United Kingdom, Poland, the Czech Republic, Denmark).
Using extreme returns on daily stock market data from 2004 until 2013, we nd
transmission effects for the tails of the returns distributions for the pre-crisis, US
crisis and euro crisis periods from the euro-periphery to the non-euro and
euro-core groups. During the crises, the shocks transmitted were more substantial,
indicating signicantly higher losses on extreme return days.
Keywords: financial crisis, financial contagion, spillover, euro crisis, stock markets
JEL classification: G01,G15
The authors are especially grateful to John Doukas (the Editor) and three anonymous
referees for very helpful suggestions. The authors also thank Gerard Hoberg, Tim
Loughran, Bill McDonald, Thorsten Lehnert, Dimitrios Gounopoulos, Chris Brooks,
Adrian Bell, George Alexandridis, Charles Sutcliffe, Chardin Wese Simen, Konstantinos
Tsiveriotis, Christoph Schommer, Themistoclis (Themis) Pantos, Theologos Homer
Bonitsis, Timothy (Tim) Alexander Carle, Gautam Tripathi, Roman Kraussl, Matti
Suominen, Kalle Rinne, Aigli Siouti, Andreas Sioutis, Cleopatra Sioutis, Alexandros
Chouliaras, Sara Goumalatsou, Eleni (Lilo) Theochari, Apostolos Christopoulos, as well as
seminar participants at the Luxembourg School of Finance and the ICMA Centre, Henley
Business School, University of Reading for helpful comments. Any remaining errors are
those of the authors alone.
European Financial Management, Vol. 23, No. 4, 2017, 728760
doi: 10.1111/eufm.12112
© 2017 John Wiley & Sons, Ltd.
1. Introduction
The recent global nancial crisis began as a crisis in the subprime mortgage loan business
in the United States of America (USA) in 2007 and continued with multiple waves of
nancial distress that hit the global nancial markets. Since the beginning of 2010, the
eurozone has been facing a severe nancial crisis (Doukas, 2012). What started as a
sovereign debt crisis in Greece soon transmitted to Portugal, Ireland, Cyprus and, at least
partially, to Spain and Italy. It soon became clear for Europe that, beneath the sovereign
debt crisis surface, there also existed a severe banking crisis (Caselli et al., 2016). The
propagation of nancial distress from one country to another, with stock markets, bond
yields and credit default swaps (CDS) spreads being affected, makes the studying of the
transmission of extreme returns more pertinent than ever.
A number of researchers investigate the recent eurozone nancial crisis and its
transmission effects, particularly emphasising the sovereign debt and CDS markets.
Missio and Watzka (2011) report the existence of contagion effects using dynamic
conditional correlation (DCC) models. Metiu (2012) employs a simultaneous equations
model and examines the tails of bond yield distributions, an approach derived from
extreme value theory and Value-at-Risk, and nds structural shift contagion effects for
the crisis periods. Other papers, however, do not nd contagion effects for the sovereign
bond and CDS markets (e.g., Caporin et al., 2013 and Bhanot et al., 2012).
The study of stock markets during nancial crises has not been sufciently examined
in the previous literature, despite their being the most liquid markets. We investigate the
stock market nancial transmission effects of the European nancial crisis (and the US
crisis) for three groups of countries: two groups of eurozone countries, the euro-core
eurozone countries (Germany, France, the Netherlands, Belgium, Finland) and the euro-
periphery eurozone countries (Portugal, Ireland, Italy, Greece, Spain), and a group for
European Union (EU) but non-euro countries (Sweden, the UK, Poland, the Czech
Republic, Denmark). The creation of these three groups is justied mainly by the
existence of the EU and the eurozone. The EU is primarily a free trade union, in which the
free movement of capital, labour and tradeable goods takes place. This has resulted in
strong ties that go well beyond these trade relationships, also taking the form of a primary
political union (with the existence of EU legislation that applies to all member countries,
the European Parliament, and various political and administrative authorities such as the
European Commission). The non-euro group is heterogeneous, but these countries
participation in the EU justies grouping them together. A subset of the EU countries has
formed the eurozone, which, as well as being a free trade area, is a monetary union,
sharing the euro as a common currency. The heads of state of the member countries of the
eurozone meet regularly to coordinate policy and make decisions. The agreed-upon
measures affect all eurozone countries. This justies the inclusion of the euro-core in our
sample, which consists of the ve countries with the highest market capitalisations
among all eurozone countries. Finally, the ve countries that were most badly hit by the
The shock transmission literature is extensive, e.g. Allen and Gale (2000), Forbes and
Rigobon (2001), Rigobon(2001), Kaminsky, Reinhart, and Vegh (2003), Pericoli and Sbracia
(2003), Bekaert, Harvey, and Ng (2005), Dungey, Fry, Gonzalez-Hermosillo, and Martin
(2005), Corsetti, Pericoli and Sbracia (2005), A
ıt-Sahalia, Cacho-Diaz, and Laeven (2015),
Haß, Koziol, and Schweizer (2014).
© 2017 John Wiley & Sons, Ltd.
Extreme Returns in the European nancial crisis 729
recent crisis are Portugal, Ireland, Italy, Greece and Spain (Doukas, 2013). These ve
countries are part of the EU and the eurozone, which is why we group them together in
the euro-periphery group. The transmission of shocks between the euro-core and the
euro-periphery is interesting, because, since the two groups are part of the same trading
union and the same monetary union, nancial problems in one group could affect the
other groups. The euro-core countries were called upon to provide nancial aid (along
with the other eurozone countries, the European Central Bank and the International
Monetary Fund) to the euro-periphery countries that were in need. Since hundreds of
billions of euros were provided in assistance, it is worth examining the effect of extreme
stock market shocks to the three country groups for one more reason: The provision of
nancial assistance may not only have been an act of solidarity, but also an act of
self-interest for the euro-core and the non-euro groups, if this nancial assistance is able
to mitigate the transmitted shocks.
The correlations framework has been widely used by previous authors in related
studies, but there is no consensus as to how to best dene contagion when using that
framework. Forbes and Rigobon (2001) claim that heteroskedasticity biases correlation
tests for contagion.
To avoid this problem we follow the extreme returns approach
proposed mainly in two papers, those of Bae et al. (2003) and Boyson et al. (2010).
Bae et al. (2003) examine the coincidence of extreme return shocks across countries
within and across groups, while Boyson et al. (2010) study hedge funds contagion. A
number of other studies have also used this methodology.
In a related paper,
Christiansen (2014) uses a sample of 14 EU countries and proposes two classication
approaches for extreme returns: One that calculates extreme returns separately for every
country and one that pools stock returns (multivariate classication scheme), and
calculates extreme returns on the overall sample. As far as extreme stock returns
are concerned, Christiansen (2014) nds that one cannot reject that the two approaches
are identical for the nancial crisis period (2008 until 2012).
What is this papers incremental contribution to the literature? First, we study for
effects that existed in the equity markets during the European nancial crisis, which were
(quite surprisingly) not sufciently examined in the previous literature, which typically
studies for contagioneffects on sovereign bonds and CDS markets (Missio and
Watzka, 2011; Missio and Watzka, 2011; Metiu, 2012; Abad et al., 2014; G
uz and
Kaya, 2014; Fabozzi et al., 2016; Banerjee et al., 2016). The study of equity markets is
signicant, since they are the most liquid markets and have the highest trading volume.
Another reason to study the effects on stock markets is the fact that during the European
Although the non-euro countries did not directly contribute to the nancial assistance
packages, they are indirectly affected through the International Monetary Fund (IMF)
contributions. On top of that, decisions to create the European Financial Stability Facility
(EFSF) and the European Stability Mechanism (ESM) in order to deal with the euro-crisis
were taken by all the EU Member States.
By applying a correction, the authors nd no contagion for the 1997 Asian crisis. On the
other hand, Corsetti et al. (2005) claim that the variance restrictions imposed by Forbes and
Rigobon (2001) are arbitrary and unrealistic. They nd evidence for at least ve countries
facing contagion effects during the Hong Kong stock market crisis of 1997.
See, for example, Markwat et al. (2009), Christiansen and Ronaldo (2009), Gropp et al.
(2009), Lucey and Sevic (2010), Chouliaras and Grammatikos (2015).
© 2017 John Wiley & Sons, Ltd.
730 Andreas Chouliaras and Theoharry Grammatikos

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