Cascading Effect of Contagion in Indian Stock Market: Evidence from Reachable Stocks

Contagion effects of stock market crisis disseminate worldwide through investors owning international portfolios. The shock transmission intrudes into other markets creating an adverse effect on the financial institutions of the concerned country. The degree of co-movement in stocks that are accessible to foreign investors in comparison with remote stocks that remain elusive to outside investors helps to predict the contagion effect. The present study attempts to examine whether the contagion effect exists in the Indian stock market. Examining the foreign investors’ reachability towards Indian stocks, the study aims to test the possibility of Indian stocks’ reachability as a channel for the transmission of financial contagion. The findings of the study reveal a significant correlation between U.S. stock returns and reachable Indian stocks in the global financial crisis period of 2008-09, rather than in the stable period. The correlation observed during the turmoil phase largely influenced the stocks accessible to foreign investors in comparison to remote stocks owned by domestic investors. Additionally, the cross-correlation results show the propagation of turbulence from reachable to remote stocks. The empirical results using two-step Maximum Likelihood estimation and Murphy-Topel variance estimates show that reachability plays a crucial role in the transposal of distress from a crisis country to another, not necessarily affected by crisis, by way of investor-induced contagion as against fundamentals-based contagion.