Please cite this article in press as: Ahrend, R., Goujard, A., Are all forms of financial integration equally risky? Asset price contagion during the global financial crisis. J. Financial Stability (2014), http://dx.doi.org/10.1016/j.jfs.2013.12.005 ARTICLE IN PRESS G Model JFS-271; No. of Pages 19 Journal of Financial Stability xxx (2014) xxx–xxx Contents lists available at ScienceDirect Journal of Financial Stability journal homepage: www.elsevier.com/locate/jfstabil Are all forms of financial integration equally risky? Asset price contagion during the global financial crisis Rudiger Ahrend, Antoine Goujard ∗ OECD Economics Department, 2 rue André Pascal, 75016 Paris, France a r t i c l e i n f o Article history: Received 17 April 2013 Received in revised form 21 October 2013 Accepted 20 December 2013 Available online xxx JEL classification: E44 F36 F44 G15 Keywords: Asset price co-movements Financial spillovers Trade spillovers External debt Foreign direct investments a b s t r a c t Using the 2008–2009 global financial crisis, this paper examines the role of different forms of international financial integration for asset price contagion in crisis times. The analysis uses bilateral financial and trade linkages and daily data on equity and bond prices for a sample of 46 countries between 2002 and 2011. Bilateral debt integration and common bank lenders are found to have transmitted financial turmoil through equity and bond markets at the height of the crisis. During this period, real trade linkages also increased equity price co-movements. By contrast, no robust evidence is found that equity or FDI integration increased asset price co-movements during the crisis. © 2013 Elsevier B.V. All rights reserved. 1. Introduction The global financial crisis has highlighted that financial turmoil can spread rapidly, as became visible e.g. in synchronised, large asset price movements across countries (Bunda et al., 2010; Frank and Hesse, 2009). Apart from an increasing correlation of economic fundamentals during financial crises, correlations in asset prices could also increase because of contagion. The strength of contagion, in turn, may depend on financial linkages between countries, and the form through which such financial integration occurs (Didier et al., 2008). This paper examines whether the depth and type of cross-border financial integration may lead to asset price conta- gion, based on a difference-in-differences identification strategy and looking at asset price co-movements prior to and during the 2007–2009 global financial crisis. Contagion can be expected to lead to an increase in co- movement of returns for certain country pairs, but not others, and our empirical strategy aims at disentangling the role of differ- ent forms of contagion during the global financial crisis. Financial ∗ Corresponding author. Tel.: +33 628306452. E-mail addresses: Rudiger.ahrend@oecd.org (R. Ahrend), Antoine.goujard@gmail.com (A. Goujard). contagion is measured as the transmission of financial market movements beyond the co-movements that would occur in “tran- quil” times (Forbes and Rigobon, 2002). For instance, contagion through bilateral debt integration is inferred if asset price co- movements increase more during the crisis between country pairs that hold large shares of their external debt, relative to country pairs whose external debt is mainly held by third-party countries. Similarly, when the banking systems of two countries have a com- mon lender, there is no reason for correlation in returns between the two debtor countries in normal times. However, during the cri- sis, capital and liquidity shocks in international banking centres may have generated large co-movement among debtor countries. A large body of both theoretical and empirical work, reviewed e.g. in Kaminsky et al. (2003), explores how financial turmoil is transmitted. Beyond the possibility that the spreading of financial turmoil may be caused by common shocks, the literature has iden- tified real trade and financial linkages as the main mechanisms of bilateral crisis transmission across countries. Both linkages can work directly or indirectly. 1 Direct trade effects arise, for example, 1 Financial and trade channels may not operate independently. For example, the co-movements of equity stocks may depend both on export prospects and firms’ dependence on international trade finance. Focusing on the United States, 1572-3089/$ – see front matter © 2013 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.jfs.2013.12.005