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Measuring Co-movements Between US and European Stock Markets

Carlo Favero () and Alessandra Bonfiglioli ()

No 165, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: In this paper we concentrate on the potential consequences for the Eu-ropean stock market of a correction of the US Stock market. We conduct our analysis by explicitly considering the distinction between interdepen-dence and contagion. By considering a Vector Error Correction Model, in which stock returns tend to restore an equilibrium relationship between the forecast earnings yield on common stocks and the yield on bonds, we provide separate answers to the following questions: (i) is there long-term interdependence between US and Europe, i.e. does the equilibrium for European shares depend on the equilibrium for US shares ? (ii) Is there short-term interdependence and contagion between US and European stock markets, i.e do short term fluctuations of the US share prices spill over to European share prices and is such co-movement stable in occasion of the occurrence of high volatility episodes?

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