Financial Market Contagion: A standard factor model approach

Firstly, this paper explores the theory behind fundamental causes and international transmission mechanisms of financial contagion. I define contagion as a structural break in the linear transmission mechanism of financial shocks. The causes of financial contagion can be found in macro-economic changes as well in changing behavior of financial agents. Secondly, this paper builds on a standard factor model of stock market returns to test for contagion in the 2007-2009 financial crisis. I find strong evidence of contagion for 15 countries out of a sample of 16.