A new study published in the Journal of Risk and Financial Management by Dr Domenico Vicinanza of Anglia Ruskin University (ARU) has examined how major stock markets on both sides of the Atlantic behaved during the Global Financial Crisis and the initial phase of the Covid-19 pandemic. The research indicates that crises do more than just cause volatility and falling share prices; they significantly increase the interconnectedness between markets.
Using a statistical technique derived from chaos theory called convergent cross-mapping, the study analysed movements in the Dow Jones Industrial Average, S&P 500, FTSE 100, and DAX. This method examines whether the dynamics of one market contain recoverable information about another, suggesting deeper nonlinear connections beyond simple correlation.
The findings showed a sharp increase in market interconnectedness during both crises. Notably, during the early months of the Covid-19 pandemic, every market relationship tested indicated a broad strengthening of links across the system. The study's average coupling measure increased by 16% from the pre-crisis period to the crisis period. These connections strengthened rapidly, with the strongest links between US and European markets appearing within three trading days.
While Covid-19 caused a sharp but relatively short spike in connectivity, the strong links between markets persisted longer during the Global Financial Crisis. The research also indicated that these connections were not unidirectional, though US markets exerted a slightly stronger influence on European markets during the pandemic.
“"This study shows that methods derived from chaos theory can provide new insights into the behaviour of financial markets. Convergent cross-mapping complements established tools such as correlation analysis and volatility measures by revealing how markets interact as complex, evolving systems and it highlights that the connections between markets can be just as important as the behaviour of individual markets."
Dr Vicinanza explained that understanding these connections is vital for risk management. "Financial risk depends on the closeness of connections between markets when stress spreads through the system," he stated. "If markets become more dynamically coupled during crises, then diversification, hedging and risk monitoring may need to take account of this changing structure."
He added that during the Covid-19 crisis, major US and European markets behaved more like parts of a single, tightly connected global system. "When markets become tightly linked, shocks can spread more rapidly, and investors have fewer opportunities to reduce risk through diversification," he noted. "Rather than being driven by local factors, markets in times of crisis become influenced by common global forces, and the behaviour of one market becomes more informative about the behaviour of others."
