Financial Markets Synchronization and Contagion : Evidence from CEE and Eurozone

We examine the synchronization of European Union (EU) financial markets before and during the recent financial crisis. A DCC-GARCH framework captures dynamic correlations and a Markov-Switching framework captures regime changes. For the 27 nations of the EU, we formulate characteristics of the crisis: transition dates, duration and intensity. As compared to established members of the EU, recent entrants to the EU entered the crisis at later dates and were less adversely affected. Consistent with the literature on financial contagion, we identify a significant strengthening of correlations between stock markets, particularly for recent entrants. Higher levels of sovereign debt and lower industrialization are associated with the intensity of the crisis experienced. In finding evidence of a core-against-periphery EU, our results refute the notion of uniform integration of EU financial markets