Risk contagion in the north-western and southern European stock markets

•We model major European, American and Japanese stock exchanges returns using three volatility models.•Several performance measures are calculated in order to evaluate VaR models.•We find that Student's-t distribution is the best choice to model heavy tails.•The concept of Granger causality in risk is used to detect contagion effects.

The paper examines risk spillover among major European, American and Japanese stock exchanges using daily stock prices from 1998 to 2011 period. More specifically, we focus more on risk spillover among major north-western stock markets (i.e. France, Germany, and United Kingdom) and southern European stock markets (Greece, Italy, Portugal, and Spain). The main motivation of the study is to use the idea of rapidly increasing interconnectedness of major stock exchanges around the World to detect the direction and the time lag of risk spillover among major stock markets. We find that the direction of statistically significant spillover is from DAX and FTSE100 to CAC40, from S&P500 to major north-western European stock markets, and from Europe to Japan (i.e. NIKKEI225). Finally, there is also a strong risk spillover effect between southern European stock markets as well as from S&P500 to southern European stock market indices.