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We provide empirical evidence that stock market crises are spread globally through asset holdings of international investors. By separating emerging market stocks into two categories, those eligible for purchase by foreigners (accessible) and those that are not (inaccessible), we estimate and compare the degree to which accessible and inaccessible stock index returns co-move with the crisis country index returns. Our results show greater co-movement during high volatility periods, especially for accessible stock index returns, suggesting that crisis spread through the asset holdings of international investors rather than through changes in fundamentals.

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Correlations are crucial for pricing and hedging derivatives whose payoff depends on more than one asset. Typically, correlations computed separately for ordinary and stressful market conditions differ considerably, a pattern widely termed "correlation breakdown." As a result, risk managers worry that their hedges will be useless when they are most needed, namely during "stressful" market situations. We show that such worries may not be justified since "correlation breakdowns" can easily be generated by data whose distribution is stationary and, in particular, whose correlation coefficient is constant. We make this point analytically, by way of several numerical examples, and via an empirical illustration. But, risk managers should not necessarily relax. Although "correlation breakdown" can be an artifact of poor data analysis, other evidence suggests that correlations do in fact change over time.

We provide empirical evidence that stock market crises are spread globally through asset holdings of international investors. By separating emerging market stocks into two categories, namely, those that are eligible for purchase by foreigners (accessible) and those that are not (inaccessible), we estimate and compare the degree to which accessible and inaccessible stock index returns co-move with crisis country index returns. Our results show greater co-movement during high volatility periods, especially for accessible stock index returns, suggesting that crises spread through the asset holdings of international investors rather than through changes in fundamentals. Copyright 2006 by The American Finance Association.