On Financial Contagion Through ETFs

On Financial Contagion Through ETFs

Alexia Thomaidou (Department of Economics, National and Kapodistrian University of Athens, Greece) and Dimitris Kenourgios (Department of Economics, UoA Center for Financial Studies, National and Kapodistrian University of Athens, Greece)
Copyright: © 2020 |Pages: 20
DOI: 10.4018/978-1-7998-2436-7.ch004


This chapter investigates the impact of the Global Financial Crisis and the European Sovereign Debt Crisis in ETFs across regions and segments. In particular, two tests are taking place, with the first one to examine if there is evidence of contagion effect and the second one to test the affection of risks in each pair of ETFs. The evidence across the stable period and the two crisis periods suggests the existence of the transmission of shocks from the Global Financial ETF to regional and sectoral ETFs. However, there is evidence that some of the ETFs remain less unaffected during both crises and some of them are immune. Moreover, the authors examine the impact of several control variables, which represent various risks, to the correlation of each pair of ETFs and the results show the influence of the interest rate risk and interbank liquidity risk during the Global Financial Crisis and the European Sovereign Debt Crisis.
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During the past decades, exchange-traded funds (ETFs, hereafter) were launched to provide an investment tool for investors who are seeking rapid and low cost exposure to equity market indices, industry sector indices and other asset classes. An ETF is a type of security that involves a collection of securities, such as stocks, that often tracks an underlying index, although they can invest in any number of industry sectors or use various strategies. Although ETFs are in many ways similar to mutual funds, they are listed on exchanges and ETF shares trade throughout the day just like ordinary stock. Choosing ETF as an investment strategy can provide a diversified portfolio without an extended investment planning. Since ETFs provide a large amount of information about the equity markets or any other market (Itzhak et al., 2012; Chang et al., 2017), this offers the opportunity to investigate the transmission of shocks among markets, segments, regions or sectors.

The purpose of this paper is to shed light on contagion effects through ETFs, by investigating how a Global Financial ETF can transmit shocks to sectoral and regional ETFs during crisis periods and providing implications for portfolio management and investments in ETFs. Taking into consideration studies about volatility and return spillovers among ETFs, the authors conduct an analysis of the transmission of shocks during two turbulent periods; the Global Financial Crisis and the European Sovereign Debt Crisis (GFC and ESDC, hereafter) using ETF daily returns, as an extension of the existing literature on the contagion effects. Forbes and Rigobon (2002) have defined the contagion as “the propagation of shocks among markets in excess of the transmission explained by fundamentals”. They support the existence of two types of contagions: pure contagion and shift contagion. The pure contagion is defined as the contagion of shocks which are not transmitted through financial, economic and market fundamentals. The shift contagion is defined as the change in the strength of the propagation of shocks between a crisis period and a normal period (Forbes & Rigobon, 2002; Pericoli & Sbracia, 2003).

Defining contagion as the excess correlation of economic and financial assets (Bekaert et. al., 2003), contagion is the outcome of optimal portfolio diversification as investors tend to choose assets without being optimal informed about them (Calvo & Mendoza, 2000). Contagion effects might also be strengthening by financial globalization. Baur (2012) found that crisis contagion is a global issue and there is no immunity to shocks even between financial sectors stocks and real economy stocks. The issue of contagion comes up in the recent literature as a result of the GFC and the ESDC. Many studies examine the contagion effects among different types of assets such as stocks, bonds, commodities, sector stock indices, hedge funds, foreign exchange markets, futures, etc. (Chiang et al., 2007; Dungey et al., 2006; Jorion & Zhang, 2007; Aloui et al., 2011, Ye et al., 2012; Brière & Szafarz., 2012; Philippas & Siriopoulos, 2013; Kenourgios, 2014).

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