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Refer to the Example 16.2 - "Contagion" Across Stock Markets Around the World. The graph shows the plots of three major stock indices - the S&P 500 in the United States, the FTSE in the United Kingdom, and the DAX in Germany. The indices tend to move together, increasing and decreasing at about the same time. Why do stock markets tend to move together? (Give the two 'general equilibrium' reasons provided by the author)

Refer to the Example 16.2 - "Contagion" Across Stock Markets Around the World. The graph shows the plots of three major stock indices - the S&P 500 in the United States, the FTSE in the United Kingdom, and the DAX in Germany. The indices tend to move together, increasing and decreasing at about the same time. Why do stock markets tend to move together? (Give the two 'general equilibrium' reasons provided by the author)

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
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Refer to the Example 16.2 - "Contagion" Across Stock Markets Around the World.

The graph shows the plots of three major stock indices - the S&P 500 in the United States, the FTSE in the United Kingdom, and the DAX in Germany. The indices tend to move together, increasing and decreasing at about the same time. Why do stock markets tend to move together?

(Give the two 'general equilibrium' reasons provided by the author)

Example 16.2 "Contagion" across Stock Markets around the World Stock markets around the world tend to move together, a phenomenon sometimes referred to as "contagion." For example, the 2008 financial crisis led to sharp stock market declines in the United States, which in turn were mirrored by stock market declines in Europe, Latin America, and Asia. This tendency of stock markets around the world to move together is illustrated by Figure 16.30, which shows the three major stock market indices in the United States (the S&P 500), the United Kingdom (the FTSE), and Germany (the DAX). The S&P includes 500 U.S. companies with the highest market value listed on the New York Stock Exchange and the NASDAQ. The FTSE (fondly described as the "footsie") has 100 of the largest U.K. companies on the London Stock Exchange, and the DAX has the 30 largest German companies on the Frankfurt Stock Exchange. (Each stock market index was set to 100 in 1984.) You can see that the overall pattern of stock price movements was the same in all three countries. Why do stock markets tend to move together? Figure 16.3 Stock Prices in the United States and Europe index 1800- 1600- 1400- 1200- 1000 800- 600- 400- 200- DAX Add S&P FISE 0 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Transcribed Image Text:Example 16.2 "Contagion" across Stock Markets around the World Stock markets around the world tend to move together, a phenomenon sometimes referred to as "contagion." For example, the 2008 financial crisis led to sharp stock market declines in the United States, which in turn were mirrored by stock market declines in Europe, Latin America, and Asia. This tendency of stock markets around the world to move together is illustrated by Figure 16.30, which shows the three major stock market indices in the United States (the S&P 500), the United Kingdom (the FTSE), and Germany (the DAX). The S&P includes 500 U.S. companies with the highest market value listed on the New York Stock Exchange and the NASDAQ. The FTSE (fondly described as the "footsie") has 100 of the largest U.K. companies on the London Stock Exchange, and the DAX has the 30 largest German companies on the Frankfurt Stock Exchange. (Each stock market index was set to 100 in 1984.) You can see that the overall pattern of stock price movements was the same in all three countries. Why do stock markets tend to move together? Figure 16.3 Stock Prices in the United States and Europe index 1800- 1600- 1400- 1200- 1000 800- 600- 400- 200- DAX Add S&P FISE 0 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Three stock market indices-the S&P 500 in the United States, the FTSE in the United Kingdom, and the DAX in Germany-are plotted together, scaled so that each starts at 100 in 1984. The indices tend to move together, increasing and decreasing at about the same time. Data from www.worldbank.org There are two fundamental reasons, both of which are manifestations of general equilibrium. First, stock (and bond) markets around the world have become highly integrated. Someone in the United States, for example, can easily buy or sell stocks that are traded in London, Frankfurt, or elsewhere in the world. Likewise, people in Europe and Asia can buy and sell stocks most anywhere in the world. As a result, if U.S. stock prices fall sharply and become relatively cheap compared to European and Asian stocks, European and Asian investors will sell some of their stocks and buy U.S. stocks, pushing down European and Asian stock prices. Thus any external shocks that affect stock prices in one country will have the same directional effect on prices in other countries. The second reason is that economic conditions around the world tend to be correlated, and economic conditions are an important determinant of stock prices. (During a recession, corporate profits fall, which causes stock prices to fall.) Suppose that the United States goes into a deep recession (as it did in 2008). Then Americans will consume less and U.S. imports will fall. But U.S. imports are the exports of other countries, so those exports will fall, reducing economic output and employment in those countries. Thus a recession in the United States can lead to a recession in Europe, and vice versa. This is another effect of general equilibrium that leads to "contagion" across stock markets.
Transcribed Image Text:Three stock market indices-the S&P 500 in the United States, the FTSE in the United Kingdom, and the DAX in Germany-are plotted together, scaled so that each starts at 100 in 1984. The indices tend to move together, increasing and decreasing at about the same time. Data from www.worldbank.org There are two fundamental reasons, both of which are manifestations of general equilibrium. First, stock (and bond) markets around the world have become highly integrated. Someone in the United States, for example, can easily buy or sell stocks that are traded in London, Frankfurt, or elsewhere in the world. Likewise, people in Europe and Asia can buy and sell stocks most anywhere in the world. As a result, if U.S. stock prices fall sharply and become relatively cheap compared to European and Asian stocks, European and Asian investors will sell some of their stocks and buy U.S. stocks, pushing down European and Asian stock prices. Thus any external shocks that affect stock prices in one country will have the same directional effect on prices in other countries. The second reason is that economic conditions around the world tend to be correlated, and economic conditions are an important determinant of stock prices. (During a recession, corporate profits fall, which causes stock prices to fall.) Suppose that the United States goes into a deep recession (as it did in 2008). Then Americans will consume less and U.S. imports will fall. But U.S. imports are the exports of other countries, so those exports will fall, reducing economic output and employment in those countries. Thus a recession in the United States can lead to a recession in Europe, and vice versa. This is another effect of general equilibrium that leads to "contagion" across stock markets.
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