Transmission of Volatility between Stock Markets

Abstract

This article investigates why, in October 1987, almost all stock markets fell together despite widely differing economic circumstances. We construct a model in which “contagion” between markets occurs as a result of attempts by rational agents to infer information from price changes in other markets. This provides a channel through which a “mistake” in one market can be transmitted to other markets. We offer supporting evidence for contagion effects using two different sources of data.