Market Integration and Contagion – The Curious Case of the Eurozone Debt Crisis

This paper analyzes financial contagion in European sovereign bond markets. It highlights the relationship between market integration and contagion and demonstrates that the disintegration of the Eurozone sovereign debt markets was a necessary condition for contagion. An analysis of extreme systemic shocks shows that contagion in the Eurozone debt crisis was not as frequent as often reported as it identifies only one major incidence of contagion that affected five periphery Eurozone countries in May 2010 coinciding with flight to quality from the periphery to the core and the 2010 “flash crash” in US equity markets. The findings demonstrate that extreme systemic shocks provide important additional information to correlation-based tests and show that there was no contagion to the core as feared by policymakers but the exact opposite of contagion – flight to quality