Abstract
With the increased level of interconnectedness among markets around the world, contagion literature has received immeasurable attention from researchers and academics over the years. In order to expand this pool of literature, this study proposes a test to distinguish between interdependence, contagion and the decoupling hypothesis between advanced markets and emerging markets based on entropy theory. The test is applied on time-varying conditional correlations obtained from an asymmetric dynamic conditional correlation generalized autoregressive conditional heteroscedasticity (A-DCC GARCH) model by comparing the extent of correlations over tranquil and turmoil periods across financial crises. In this study, the US and EU are identified as advanced economies and emerging markets are identified by region with the aim to uncover whether they are homogenous or heterogenous as receivers of shocks from advanced economies. Our findings present evidence in support of the decoupling hypothesis in the cases of Brazil and Russia during the GFC and Turkey during the ESDC. Furthermore, strong evidence in support of the existence of contagion effects between advanced and emerging markets is reported and the presence of interdependence was constantly rejected. The findings of this study provide valuable insights for policy makers, investors and asset managers.
Keywords: Contagion, interdependence, decoupling, A DCC GARCH, entropy test, emerging markets, advanced markets.