Dynamic correlation analysis of financial contagion: Evidence from the Central and Eastern European markets

This paper applies the Dynamic Conditional Correlation (DCC) multivariate GARCH model of Engle (2002), in order to examine the time-varying conditional correlations to the weekly index returns of seven emerging stock markets of Central and Eastern Europe. We used weekly data for the period 1997-2009 in order to capture potential contagion effects among the US, German and Russian stock markets and the CEE stock markets. The main finding of the present analysis is that there is a statistically significant increase in conditional correlations between the US and the German stock returns and the CEE stock returns, particularly during the 2007-2009 financial crises, implying that these emerging markets are exposed to external shocks with a substantial regime shift in conditional correlation. Finally, we demonstrated that domestic and foreign monetary variables, as well as exchange rate movements have a significant impact on the corresponding conditional correlations. Macroeconomic fundamentals have been shown to have substantial explanatory power in explaining these conditional correlations during the financial crisis of 2007-2009.