What drives European Union stock market co-movements?

This paper analyses the co-movements and contagion between 24 European Union stock markets. We apply a Dynamic Conditional Correlation - Mixed Data Sampling model to extract short and long-run correlations. We use short-term correlations to detect contagion. Finally, we employ a gravity-type regression to investigate the determinants of long-term correlations. First, we find significant differences between the stock market co-movements, which seem to depend on economic development and market deepening. Moreover, the time varying correlations emphasize different phases of development, i.e. integration, contagion, and divergence. Second, the contagion estimates reveal that, during some crisis episodes, the contagion is temporary, while for other periods the contagion becomes more persistent, indicating a herding behavior. Third, the co-movements determinants show that global factors and economic similarities are important in explaining correlations. Finally, our findings on long-term correlations drivers in contagion times are mixed, revealing, on the one hand, a pure contagion that is not explained by fundamentals, and, on the other hand, a wake-up call in terms of cross-border bank flows.