International equity markets interdependence: bigger shocks or contagion in the 21st century?

We investigate the nature of shocks across international equity markets and evaluate the shifts in their comovements at business-cycle frequency. By using a parsimonious “identification through heteroskedasticity” methodology, we compute the impact exposures of index returns to common and country-specific shocks. We then establish some key results regarding comovement amongst international returns and macroeconomic fluctuations over the last decades. First, across all indices, persistent spells of high-volatility and high cross-market correlation always coincide with macroeconomic slowdowns and with measured shifts in macroeconomic and financial uncertainty. Second, there is a rise in the observed responses of international stock returns to common shocks during turbulent periods; however, such increase is largely attributable to bigger shocks (heteroskedasticity of fundamentals) rather than to breaks in the transmission mechanism or increased structural interdependence between markets. This holds for the Great Financial Crisis too. Third, since around the turn of the millennium, returns have more often experienced high volatility and comovement, likely because of larger and persistent macroeconomic disturbances.