The contagion channels of July‐August-2011 stock market crash: A DAG-copula based approach

The objective of this paper is to empirically investigate whether there is a contagion phenomenon between the stock markets during the July–August‐2011 stock market crash. When there is a market contagion, we will identify the propagation channel through which the crash is transmitted. Hence, after checking if there is financial contagion between the stock markets, we will see if the transmission mechanism ‘constraints of wealth’ outweighs that of the ‘portfolio rebalancing’. An additional test covering the interdependence between the stock and bond markets during the crash helps us verify whether the transmission is due either to the ‘cross‐market rebalancing’ channel or to the ‘flight to quality’ phenomenon. On the basis of the combination of the copula theory and the directed acyclic graph to study the structure of causal dependence between the stock market during the period that lies between 01/02/2010 and 28/11/2012, we show that the links between countries are different between the pre‐crash period and that of the crash. More specifically, the links that do not exist during normal times seem to have a major role during the crash period. We interpret this result as an evidence of the existence of pure contagion. On the one hand, the tests show that the channel of the ‘portfolio rebalancing’ was the major mechanism for the spread of the crash. On the other hand, the phenomenon of the cross‐market rebalancing existed only in Germany; whereas, that of the flight to quality was in all the other studied stock markets.