Crises in Developed and Emerging Stock Markets*
Sandeep Patel
J. P. Morgan Securities

Asani Sarkar
The Federal Reserve Bank of New York

Abstract
We empirically examine stock index data for eight developed and ten emerging
markets from 1970 to 1997. There were nine stock market crises over our sample
period, three each in the developed stock markets, the Asian stock markets andthe Latin American stock markets. We find important differences in the characteristics of stock market crises between the developed and emerging stock markets. While developed market crises have become less severe over time, both interms of the extent of price decline and the duration of the crises, this is not so forthe emerging stock markets. In emerging market stock crises, prices tend to fall
rapidly and steeply, and take longer to recover—about three years on average. For
both developed and emerging markets, prices fall for at least three years subsequent to recovery from a crisis. All the crises are associated with contagion, inthat a crisis in one market is followed by crises in most other markets in theregion. Finally, for U.S. investors with long investment horizons (six months ormore), international stocks continue to provide diversification benefits evenduring times of market crises.

*
We thank seminar participants at the Federal Reserve Bank of New York. The views statedhere are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of
New York, or the Federal Reserve System. All errors and omissions are our responsibility alone.

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The recent episodes of large price declines in Asian stock markets have once
again drawn attention to the consequences of international stock market crises.
What are the magnitudes of stock price declines during crises? Is there evidenceof contagion during these crises—i.e., do several markets experience a crisis
simultaneously? Finally, international investments are beneficial to U.S. investors
if correlations between U.S. and non-U.S. stock markets are low. How do stock
market correlations change during a crisis, and is this dependent on how long
investors hold their stocks?
There is relatively little research on international stock market crises, whereas
there is an extensive literature on international currency crises and the U.S. stock
market crash of 1987. Roll (1989) provides a summary of the literature on the U.S.
stock market crash of 1987 and Kaminsky, Lizondo and Reinhardt (1997) review
the results of 25 selected studies on currency crises. In the next section we
provide an updated and comprehensive review of the literature on currency andU.S. stock market crises.
This article contributes to the crisis literature by empirically examining stockindex data for eight developed and ten emerging markets from 1970 to 1997.
Our methodology identifies nine stock market crises in the 18 countries during
our sample period. These nine crises coincide with several well-known financial
crises of recent times: the oil price shocks of 1974 and 1979, the Latin American
debt crises of 1982 and 1994, the 1987 U.S. stock market crash, and the East
Asian crisis of 1997 (see Box 1). We study stock price changes before and after
these episodes to document price increases prior to crashes and the price recovery
following crashes. We document the extent of contagion during crises and examine whether the correlation between stock market indices changes during episodesof significant price declines.
The remainder of the paper is organized as follows. The first section summarizes the literature on currency and U.S. stock market crises. The second section
describes the data, and the construction of regional indices. We proceed to identify stock market crises for our sample period, and characterize the behavior ofstock market indices surrounding the crisis episodes. Finally, we analyze theextent of contagion and the change in correlations between markets during thesecrises. To supplement the technical analysis, we provide in Box 1 a chronology of
economic and political events surrounding the stock market crises identified in
the paper.

Literature survey
The crises literature has mostly focused on currency crises and the U.S. stock
market crash of 1987, and examined issues related to the causes of crises, pricechanges (including, among other economic variables, stock returns) surrounding
the crises, international market linkages, contagion, and changes in benefits tointernational diversification. In our paper, we examine these same issues for 18

Crises in developed and emerging stock markets

263

international stock markets from 1970 to 1997.
The U.S. stock market crash of October 1987 has been studied extensively.
Black (1988), Fama (1989) and Roll (1989) seek to explain the crash in terms ofshifts in fundamental factors, such as downwards revisions in expectations about
global economic activity, or higher equilibrium required returns. In contrast,
Seyhun (1990) concludes, based on the behavior of corporate insiders, that investor overreaction was an important part of the Crash. His evidence showed that,while the Crash was a surprise to insiders, they bought stocks in record numbers
immediately after the Crash, especially those stocks which had declined the most,and these stocks had large positive returns in 1988.1 Norden and Schaller (1996)
use regime-switching regressions to conclude that the degree of prior market
overvaluations explains subsequent U.S. stock market crashes for the period
1926-89.
The U.S. stock market crash inspired several studies on the international links
between stock markets. In early literature, Solnik (1974) showed that international investments are beneficial for U.S. investors since correlations between U.S.
and non-U.S. markets are low. Bennett and Kelleher (1988) find that the transmission of stock price volatility between markets was greater than normal during the
Crash, and that periods of high daily volatility are associated with high correlations between markets. Neumark, Tinsley and Tosini (1991) show that correlations between stock market prices of different countries increase during times ofextreme volatility and become small or close to zero during more normal periods
and suggest that transactions costs may explain this pattern of asymmetric correlations. In a recent paper, Lin and Ito (1994) find a significant increase in thehourly return correlation between the S&P 500 index and the Nikkei 225 from theTokyo Stock Exchange (TSE) during the 1987 crash period.2
In related research, Aderhold, Cumming, and Harwood (1988) conclude that
direct international linkages cannot account for the worldwide decline in equity
markets in October 1987. Cross-border selling of equity was a factor only inTokyo, and stock trading outside the home market mainly affected U.K. securities
traded in the form of American Depository Receipts (ADRs). However, in the
weeks after the crash, investors liquidated equities and reduced financial investments, but not to the extent anticipated.
There is a large literature on international currency crises. One strand of this1
Other papers have examined whether the October Crash was a speculative bubble—i.e., thecrash occurred following a period when investors persistently overvalued the market. Shiller (1987)
provides survey evidence that, before the Crash, almost 72 per cent of individual investors and 84
per cent of institutional investors thought the market was overvalued. Hardouvelis (1988) finds
evidence that excess stock returns prior to the Crash were greater than normal in the U.S., Japan andGreat Britain, and he attributes the abnormally high excess return to a bubble premium.
2
One puzzling aspect of the 1987 crash was the behavior of the S&P 500 index of the New York
Stock Exchange (NYSE). For example, the index exceeded the corresponding futures price (negativebasis), displayed unusually strong and persistent serial correlation, and unusually low variance.
Harris (1987) shows that nonsynchronous trading in the stocks making up the index cannot accountfor the large (absolute) value of the basis. Kleidon (1992) argues that stale limit buy orders canaccount for the behavior of the S&P 500 index.

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literature seeks to develop early warning signals of exchange rate crises. Kaminsky, Lizondo and Reinhardt (1997) review the results of 25 selected studies oncurrency crises and identify 103 crisis indicators. A second strand of the currency
literature examines the issue of currency contagion. For example, Sachs, Tornell
and Velasco (1996) show that countries with weak fundamentals are more susceptible to contagion. Eichengreen, Rose and Wyplosz (1996) find that, after
controlling for the effects of economic and political variables, the probability of a
speculative attack on a currency increases eight percent when a crisis occurs
elsewhere in the world.3

Data and regional index construction
We use monthly dollar-denominated returns on stock indices, supplied by Morgan
Stanley Capital International (MSCI), for eight developed countries (Switzerland
and the G7 countries: Canada, France, Germany, Italy, Japan, U.K. and U.S.A.)
from January 1970 until December 1997. We also use dollar-denominated returns
on stock indices for ten emerging market countries: six Asian emerging markets(Indonesia, S. Korea, Malaysia, the Philippines, Taiwan, and Thailand) and four
Latin American emerging markets (Argentina, Chile, Brazil, and Mexico). Thisdata is available from January 1976 until December 1997, and was obtained fromthe Global returns series of the International Finance Corporation (IFC).4
The country returns are combined into three regional dollar-denominatedindex returns for the Developed markets, Asia and Latin America. The monthly
regional return is constructed by equally weighting the monthly returns of eachcountry in the region.5 The three regional index levels at time t are obtained bycumulating the corresponding monthly regional returns up to time t.

A history of regional stock price declines
To identify periods of significant price declines in the history of the regions, wedefine a variable called CMAXt which is the ratio of the regional index level attime t to the maximum regional index level for the period up to time t.6 Figure 1
3
There is also a growing literature on international banking crises. Kapur and Ma (1997) review
selected research from this literature. Rojas-Suarez (1998) proposes early warning indicators forbanking crises in emerging markets, based on bank-specific variables.
4
The MSCI and IFC data sets have been widely used in previous work. The methodologicalnotes from both indices provide detailed descriptions of the data. To obtain the longest possible
sample, we have used the Global (instead of Investible) returns series from the IFC. The sample
period for Malaysia, the Philippines and Taiwan begins in January 1985 and that for Indonesia
begins in January 1990.
5
Alternative weighting schemes may include market capitalization (which is not available forthe full time series in our sample), nominal and purchasing power GDP. We could also have equallyweighted the returns on an annual, rather than monthly basis.
6
The variable CMAXt is widely used by equity market practitioners. For example, it has beenused in “MSCI Perspective,” a monthly publication of Morgan Stanley providing index and indexconstituent data, and in the Barra-Forbes page of Forbes magazine. We define CMAXt in nominal

Crises in developed and emerging stock markets

265graphs the value of CMAXt from 1970 until the present for the three regions,developed markets, emerging Latin America and emerging Asia.
All three regions have experienced episodes of large price declines. However,as may be expected, price declines in the emerging markets are typically larger inmagnitude than price declines in developed markets. For example, in the developed markets, there were three episodes where the regional price index declined
more than 20% relative to the previous historical maximum level, but there were
six such episodes for Asian markets and four such episodes for Latin American
markets. In addition, there was only one instance when price declines in developed markets exceeded 35 per cent, with the largest price decline being 39.9
percent in September 1974. In contrast, there were six such episodes for emerging
Latin American and Asian markets—for example, Asian stock indices declined
almost 68 per cent relative to their historical maximum by December 1997.
We define a stock market crash as an event when the regional price index
declines, relative to the historical maximum, more than 20 per cent for the developed markets, and more than 35 per cent for the emerging markets.7 The beginning of the crash is the month when the price index falls below this thresholdlevel. The beginning of a crisis is the month when the index reached its historicalmaximum prior to the month when the crash is triggered. The date of trough isthe month when the price index reaches its minimum level during the crisis. The
date of recovery is the first month when the index reaches the pre-crash maximum
level after the crash is triggered. To avoid counting the same crisis twice, additional triggers occurring within a crisis are considered part of the existing crisis,
instead of being an indicator of a new crisis.
To illustrate our definition, consider the Latin American crisis of 1981. In July
1981, the Latin American regional index fell 36.14% below its historical maximum level. Since the decline exceeds the trigger of 35%, we identify this episodeas a crash. The beginning of the crisis was June 1980, the month that the Latin
American regional index achieved its historical maximum. The crisis ended 65
months later, in November 1985, when the Latin American index recovered to its
previous maximum level of June 1980. There were additional trigger points
during this crisis, such as December 1982, when the regional index declined
almost 69% below the historical maximum level of June 1980. These additional
triggers are considered part of the June 1980 crisis, rather than the beginning of a
new crisis.
Episodes of crises can be identified in many ways. Box 1 shows that ourdefinition successfully captures nine well-known financial crises. Six of the ninecrises were related to terms-of-trade shifts: the first developed market crisis ofdollar terms. In future analysis, we may also define CMAXt in real dollar or real local currency
terms.
7
For the developed markets and Asia, the trigger price represents a level about two standard
deviations below the mean value of CMAXt. For Latin American markets, the trigger price is about
one standard deviation below the mean value of CMAXt, reflecting the higher volatility of thesemarkets. For the sake of consistency, we wanted to have one trigger level for all emerging markets.

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1973 and the crises affecting all three regions in 1980-1981 were related to the oil
price increases; the Latin American crisis of 1994 and the current Asian crisis
were related to currency over-valuation under pegged exchange rate regimes. Of
the remaining three crises, the 1987 crises in developed and Latin Americancountries were associated with the U.S. stock market crash and the Asian crisis of1990 was a result of several simultaneous political and economic shocks.
Table 1 provides further information on regional crises. The “Months totrough” column shows the number of months over which the regional index
reached the trough. The “Months to recovery” column shows the number ofmonths taken for the regional index to recover. The duration of a crisis is thenumber of months taken to fall to the trough and then recover to the previous
peak.
Since 1970, there have been three crises in the developed markets, each lesssevere than the one before. The crisis duration for the developed markets has
fallen from 59 months for the first crisis of June 1973 to 17 months for the lastcrisis of August 1987. The maximum price decline during a crisis has also fallenfrom almost 40 per cent for the first crisis to about 22 per cent for the final crisis.
There have been three crises each in the Latin American and Asian stock
markets since 1970. In contrast to the developed markets, the severity of thecrises shows no signs of declining. In fact, the emerging market crises have mostin common with the first (and most severe) developed markets crisis of 1973.
The emerging market crises tend to be quick and steep, but with long periods ofrecovery and crises duration. Even then, recovery occurs in less than three years.
The maximum price decline in a crisis was around 40 per cent for four of the six
crises, and exceeded 60 per cent in the other two.
In all nine crises, stock price crashes have been preceded by significant priceincreases, with the median value of the annualized returns for the three years prior
to the crises being almost 49 per cent. This is consistent with the results of Roll
(1988), who found substantial price increases in many international stock markets
in the nine months prior to the October 1987 stock crash. Our results show thatthe magnitude of pre-crisis price increases is typically larger for emerging markets than for developed markets. Further, for emerging markets, the averageannual price increase for the three years before the crises exceeds the maximum
price decline in the crises—a feature that may be consistent with a “bubble” (see,for example, Allen and Gale 1998). Interestingly, this “bubble”-type feature is notpresent in the recent Asian crisis, where the annual pre-crisis price increase wasonly a third of the maximum price decline in the crisis.
A surprising result is that, in all nine crises, prices have fallen following
recovery, with the median value of the annualized returns for the three years after
the crisis being about negative nine per cent.

Crises in developed and emerging stock markets

267

Lead-lag relationship between stock price declines and advances
We saw, in Table 1, that stock prices rise significantly prior to regional crises. To
further examine the behavior of stock prices prior to episodes of significant pricedeclines, we define a variable called MINCt, defined as the ratio of the minimum
index level for the three-year period prior to time t to the index level at time t.
Figure 2 graphs MINCt for the three regions and the period January 1970 until
December 1997.
Analogous to Figure 1, there were several episodes of significant price increases in all regions and the magnitude of such increases was larger for the
emerging markets. Further, for each region, price increases tended to be larger
than price declines, reflecting the fact that stock prices tend to go up over time.
The developed markets, for example, experienced price increases of more than
200 per cent leading up to the crash of 1987. The emerging Latin American
markets experienced price increases close to 400 per cent leading up the crisis of
the early 1980s.
These observations suggest that stock market crises may be systematically
preceded by episodes of significant price increases. To examine this idea moreformally, we calculate the correlation between CMAXt+lag and MINCt for various
values of lag ranging from - 60 months to + 60 months. When the value of lag is
negative, the correlation indicates whether price increases lead the subsequent
price decline. For example, suppose lag is - 60 months (i.e., 60 months prior to t),
and t is January 1990, and the correlation between CMAXt-60 and MINCt is positive.
This means that if, five years ago in January 1985, the index level was close to its
historical high, then in January 1990, the price is likely to be close to its previous
minimum. In this case, above-average index levels are likely to be followed by
below-average index levels—i.e., prices are mean-reverting. If the correlation isnegative, then high values of index levels are likely to be followed by still higher
index levels—i.e., prices are positively auto-correlated.
We plot, in Figure 3, the correlation between CMAXt+lag and MINCt for different values of lag. In addition, Figure 3 includes bands for values of three standard
deviations above and below the mean correlation. The correlation declines from amodest positive value to a large negative value for all three regions, as the lagvalue goes from negative 60 months to zero. This means that, over short intervalsof time (small values of lag), prices are positively autocorrelated. This is consistent with Roll (1989), who finds similar positive autocorrelation for holding
periods from 2 days to 20 days for stock returns of 23 countries in the pre-1987
crash period. A new result here is that the degree of short-horizon autocorrelationis larger for emerging markets than for the developed region. For longer timeintervals (large values of lag), prices are mean-reverting. This result is consistent
with previous work on developed markets (see Campbell, Lo and Mackinlay 1997
for a summary).
When the value of lag is positive, the correlation indicates whether pricedeclines lead the subsequent price increases. From Figure 3, for all regions, the268

Sandeep Patel and Asani Sarkar

correlation is negative for small positive values of lag but increases to a positive
value for larger positive lag values. The lag value at which the correlation turns
positive varies by region, being about 7 months for the developed markets, 15months for Asian markets, and 33 months for Latin American markets. As the lagvalues increase further, the correlation reaches a peak and then starts declining
again. The lag value at which the correlation peaks is the period of time after
which the probability of recovery is the strongest. This lag value, too, varies byregion, being largest for Latin America, followed by Asia, and the developed
region. These results indicate that, consistent with our earlier findings, the periodof recovery is longer for emerging markets than it is for developed markets.

Individual market crises and contagion
Is a regional crisis typically associated with an individual market crisis?8 In
Figure 4 we show, corresponding to each regional crisis, the individual markets in
the region that are also in crisis. Each band illustrates the duration of an individual market crisis, with the beginning and end of a band dating the beginning andend of the crisis. It is clear that, for all episodes of regional crises, half or more of
the individual markets were affected. An interesting aspect of Figure 4 is that
there were several instances when individual markets were in crisis, but this did
not spill over into a regional crisis. However, since 1990, there is an increasing
tendency for markets in Asia and Latin America to move together.
In Table 2, we examine the behavior of individual country stock prices when
the region is in crisis. All regional crises are associated with contagion, in thesense that most countries in the region participate in the stock market decline. For
the developed markets and Latin America, there is little difference in the means
and medians of individual country crises’ duration, which suggests that all countries participating in the regional crisis suffer for roughly equal amounts of time,
although the dates when the crisis began and ended varied across countries.
However, this is not the case for Asia, where Indonesia and S. Korea have been incrisis longer than the other Asian stock markets. The means and medians of the
maximum country stock price declines are similar in all regions, including Asia,
indicating that, in almost all regional crises, the individual countries in crises areabout equally affected. Most individual stock markets experience negative postcrisis returns for at least three years.
An examination of when individual countries in a region go into crisis reveals
a “bunching” effect—that is, two or more markets become critical in the samemonth or within one month of one another. This is particularly true for the developed markets. For example, in the 1987 crisis, France and Italy became critical in
8
Markets in a region may move together for various reasons. The markets may be regionallyintegrated through trade flows, and so shocks in one market are naturally transmitted to othermarkets. Alternatively, shocks may be transmitted even when economic links between countries are
weak. We document the degree to which markets move together, but make no attempt to explain
why they do so.

Crises in developed and emerging stock markets

269

April 1987, Canada, Germany and the United States became critical in August
1987, while Switzerland and the U.K. followed suit in September 1987. All thesecountries experienced negative returns following the end of the crisis, except
Italy.
Even though contagion within a region is endemic, the evidence does notindicate significant contagion across regions. This leads us to examine how thediversification benefits of U.S. investors are affected during a crisis.

Diversification benefits of U.S. investors
In this section, we examine the crises from the point of view of a U.S. investor.
U.S. investors are often advised to hold both domestic and foreign stocks in theirportfolio. Since U.S. and non-U.S. markets do not move one-for-one (they areimperfectly correlated), such a portfolio can be less risky, without sacrificing
returns, relative to a domestic stock portfolio. However, a common belief is that
U.S. and emerging markets have high correlations when the U.S. market is falling,so that “when you need diversification, you don’t get it, and you get it when you
don’t need it.” (Graja 1998).
To address this issue, we examine the correlation between the U.S. markets
and the remaining developed markets (excluding Japan), as well as Asia and Latin
America. We first sort the monthly index returns for all three regions by the valueof the U.S. returns, and then, for each region, we distribute the observations into
the lowest and highest 25 percent of U.S. returns, and the middle 50 per cent of
U.S. returns. Correlations between the U.S. returns and returns of the other two
regions are calculated for the lowest, highest, and middle U.S. returns, as well as
for the whole sample. We repeat this exercise after sorting the observations by the
non-U.S. returns.
The results are in Table 3. Panel A reports the correlations for a hypotheticalinvestor who holds stocks for one month and then liquidates his portfolio. The
correlations are high and positive for all three regions for the lowest quarter
returns, and close to zero or negative for the highest quarter returns. These results
show that, for one-month holding periods, U.S. and international markets move
together in periods when U.S. returns are low. The same result holds when themonthly returns are sorted by the non-U.S. market returns. Thus, U.S. investors’
diversification benefits are diminished in periods when markets perform poorly.
Panel B of Table 3 displays the same set of correlations, except that we assume that the investor holds the stocks underlying the indices for a period of one
year. The procedure for computing correlations is the same as before, except that
we first compute one-year returns for all regions. The results are quite different,
especially for Asia. The overall correlations are lower. More important, the correlation for the lowest returns is zero for Asia. Again, the result is true whether
we sort the returns by the U.S. returns or the non-U.S. returns.
These results are generalized in Figure 5, where we show correlations for270

Sandeep Patel and Asani Sarkar

holding period returns between zero and 30 months. For each holding period, we
compute the corresponding holding period returns for the U.S. returns. For thelowest 25% returns, Figure 5 shows the pair-wise correlations between the U.S.
and non-U.S. markets. The correlations between U.S., other developed markets
and emerging markets (both Asian and Latin America) decrease with the holding
period, eventually becoming zero for a sufficiently long holding period. Our
results demonstrate that emerging market investments reduce the risk of U.S.
investors’ stock portfolio, provided the investor holds the stocks for a sufficiently
long time.

Conclusion
We empirically examine stock price index data for eight developed and ten
emerging markets from 1970 to 1997. We identify episodes of significant pricedeclines (“crashes”) and discuss stock price behavior surrounding these episodes.
We examine stock price changes before and after these episodes to document
price increases prior to crashes and the price recovery following crashes. We
document the extent of contagion during crises and examine whether the correlation between stock market indices changes during episodes of significant pricedeclines.
We identify nine stock market crashes over our sample period: three in thedeveloped markets, when price index levels declined more than 20 per centrelative to their historical maximum, and six in emerging markets, when index
levels fell more than 35 per cent relative to their historical maximum. Crashes
tend to be quick and steep, but prices do recover, usually in three years or less.
Emerging markets tend to have larger price declines and longer recovery times
than developed markets. The process of crash and recovery together typicallylasts about 31 months. However, for the three years subsequent to the recovery,stock prices tend to decline again, although not with the same severity as during
the crash.
Prices tend to rise prior to a crash, and the magnitude of price increases is also
larger for emerging markets. For short horizons, prices are autocorrelated,
whereas for longer horizons, there is evidence of mean reversion. This means that,over longer horizons, prices do recover from a crash. However, the recovery time
is longer for emerging markets and, within emerging markets, longer for Asia
than Latin America.
There is strong evidence of contagion within regions, in that a crisis in one
country is followed by crises in most other countries in a region. Stock markets inthe crisis are affected about equally, both in terms of the severity of the pricedecline, and the duration of the crisis. The crisis perpetuates rapidly from one
market in a region to the next, with consecutive markets being affected in thesame month or within one month of one another.
We confirm the often-held belief that correlations between U.S. and emerging

Crises in developed and emerging stock markets

271

markets tend to become higher in times of market decline. However, this is only
true for investors who hold stocks for short periods of time—for less than one
year, in the case of Asian stocks. For longer-horizon investors the correlations
remain very small even when markets fall. For these investors, emerging market
stocks continue to provide important diversification benefits even during periodsof significant market declines.

272

Table 1: A chronology of regional crises

Beginningof crisis

Beginningof crash

Date oftroughDate ofrecoveryMonths totroughMonths to Price decline
recoveryto troughAnnual returns
before crisis
One
Three
year
years

Annual returns
after crisis
One
Three
year
years

25.0
31.1
26.8

24.2
25.7
48.7

-5.0
-5.0
-7.4

-7.5
-15.5
-5.3

71.0
67.9
63.5

66.8
64.4
37.2

-4.0
-29.0
-2.5

-10.1
-37.4
-1.6

33.8
44.7
20.3

51.6
55.6
21.6

-7.9
-10.3
NA

-15.8
-6.4
NA

Panel A: Developed stock markets
197306
198010198708197405198206
198711

197409198206198801

197802
198303
198901

15
20
5

41
9
12

39.9
22.9
21.5

Panel B: Latin American stock markets
198006198709199409198107
198711
199502

198212
198711
199502

198511198805199702

30
2
5

35
6
24

68.4
38.2
38.2

Panel C: Asian stock markets
197812199003
199604

198008199009199708198010199009199712

198510199308
199712

22
6
20

60
35
NA

43.7
37.7
67.9

Sandeep Patel and Asani Sarkar

A crash is triggered when, relative to the previous maximum, the regional stock price index declined more than 20 percent in the developed markets or more than 35 per cent in the emerging markets. The beginning of a regional crises is thedate when the index reached its maximum just prior to the trigger time. The end of a crisis is the date when the index
reached the pre-trigger maximum level the first instance after the trigger time. We exclude triggers occurring within six
months of the initial trigger time.

Table 2: Individual market crises and regional crises
A crash is triggered when, relative to the historical maximum, a country’s stock price index declined more than 20 percent in the developed markets or more than 35 per cent in the emerging markets. The beginning of an individual market
crises is the date when the index reached its maximum just prior to the trigger time. The end of a crisis is the date when
the index reached the pre-trigger maximum level the first instance after the trigger time. We exclude triggers occurring
within six months of the initial trigger time.

8
5
7

197204
198010198704

197308
198104
198710Duration of crises
Maximum price(months)
decline in crises
Months toMonths totroughrecovery
Mean Median Mean Median Mean Median

Annualized mean returns
Before crises

After crises

One
year

Three
years

One
year

Three
years

43.9
43.8
29.4

40.6
46.8
36.0

23.2
30.9
46.5

-3.1
-10.4
-3.2

-4.1
-12.3
-8.1

90.2
80.3
52.2

87.6
*
47.5

239.3
411.4
85.8

76.0
99.9
72.0

-1.4
-9.5
NA

-7.4
-9.4
NA

54.6
68.6
77.5

*
76.2
77.1

42.1
83.6
41.9

59.1
62.2
31.7

-8.0
NA
NA

-14.0
NA
NA

Panel A: Developed stock markets
22.4
18.5
33.5
38.5
47.6
12
11
23
19
38.8
7
5
17
18
31.1
Panel B: Latin American stock markets

3
2
3

197904
198604
199401198005198609199412

54
11.5
10.7

56
*
13

58
50
NA

51
*
NA

Panel C: Asian stock markets
2
5
5

197808
198903
198903

197905199008199005

31
44.2
51.4

*
8
38

61
NA
NA

*
NA
NA

Crises in developed and emerging stock markets

Number of
Beginning of Beginning ofcountries in crisis first crisis
first crash

273

274

Table 3: Stock market correlations

RegionSorted by U.S. stock returns
Overall
returns

Lowestquarter
returns

Highestquarter
returns

Sorted by non-U.S. stock returns
Middlehalf
returns

Overall
returns

Worst
quarter
returns

Highestquarter
returns

Middlehalf
returns

0.52350.45400.43240.2419-0.0850-0.1656

0.264-0.0635
0.1076

0.5612-0.1373
0.04490.30110.1031
0.56880.2274-0.1165-0.0767

Panel A: One Month Returns
Developed
Asia
Latin America

0.57530.22350.16640.55930.36270.413

0.1676
0.0520-0.2388

0.1605-0.0775-0.2268

0.57530.22350.1664

Panel B: One Year Returns
Developed
Asia
Latin America

0.5461-0.0950.13580.3966-0.0001
0.3586

0.0696
0.0432-0.22410.17450.1184-0.02410.5461-0.0950.1358Sandeep Patel and Asani Sarkar

U.S. stock returns are sorted by their magnitude. Pair-wise correlations are computed for the overall sample, for thebottom and top quartiles, and for the middle half separately. For the second set of correlations, the non-U.S. stock returns
are sorted by their magnitude, and pairwise correlations are computed as above. The developed markets exclude the U.S.
and Japan.

Crises in developed and emerging stock markets275

Box 1: A History of Stock Market Crises
The Developed Markets
1. The 1973-74 crisis, involving all eight developed markets in our sample,
was preceded by the quadrupling of the oil price by OPEC in 1973 andthe consequent increase in the external debt of non-oil producing developed countries. In addition, the Gold Standard was suspended and theforeign exchange market closed down for two weeks following frequent
revaluations of the world’s major currencies. The developed country
stock markets, with the exception of Canada, had all peaked by June
1973. The Italian stock market crashed first, in July 1973, followed by
the U.K. stock market a month later. Stock markets in Japan, France andGermany crashed between November and December of 1973. Canada
and the U.S. crashed in April and June of 1974, respectively.
Recovery Germany recovered in only four months, and Switzerland in
16 months. The other six countries took between 27 months (U.S.) and52 months (Canada) to recover.
2. The 1980-81 crisis, involving Canada, Japan, France, Italy and the U.K.,
was preceded by dramatic increases in gold prices in 1980, and the doubling of the oil price by OPEC in 1979, leading to balance of payment
problems for non-oil producing countries, especially in the emerging
market countries. Canada, France, Italy and the U.K. peaked between
October 1980 and May 1981. The French stock market crashed first, in
April 1981, followed two months later by Italy and by France and the
U.K. after another three months. The Japanese stock market did not peak
until December 1981 and it did not crash until July 1982.
Recovery Japan recovered in only two months, and Canada and the U.K.
took 19 months or less. But France and Italy took more than three years
to recover.
3. The crisis of 1987, involving all developed markets in our sample otherthan Japan, originated in the U.S., when prices at the New York Stock
Exchange fell by one third over five trading days in October, triggeredby high trade deficits and proposed takeovers related legislation. The
major developed stock markets had all reached their peaks between
April and September of 1987. The crisis spread to all of them, except
Japan, in October 1987 (except Switzerland, where the market crashedin November).
Recovery The recovery took between 11 months (Switzerland) and two
years (Italy).

276

Sandeep Patel and Asani Sarkar

Box 1, continued
The Latin American Markets
1. The 1980-81 crisis, involving Argentina, Chile and Mexico, originatedwith the doubling of the oil price by OPEC in 1979, leading to balanceof payment problems for non-oil producing countries, especially in theemerging market countries. In 1982, Brazil, Argentina and Mexico announce their inability to meet foreign debt obligations. Argentina, Chileand Mexico had peaked between April 1979 and June 1980. The stock
market in Argentina crashed first, in May 1980, followed by Chile andMexico in July 1981.
Recovery Recovery was prolonged, lasting between four years for Chileand 75 months for Argentina.
2. The crisis of 1986-87 involved Brazil and Mexico. The Brazilian stock
market peaked in April 1986, thanks to increased economic growth following the economic stability, or Cruzado Plan, but crashed in September of the same year due to the government’s failure in implementing
economic reforms. The U.S. stock market crash of 1987 perpetuated theBrazilian crisis and brought on a new crisis in Mexico, where the stock
market peaked in September 1987 and crashed the following month.
Recovery Recovery took 29 months for Mexico and 71 months for Brazil.
3. The crisis of 1994-95 involved Argentina, Brazil and Mexico. The crisis
was preceded by an increase of almost 85 per cent in the U.S. Federal
Funds interest rate over the course of 1994, and the unexpected devaluation of the Mexican peso in December 1994. Stock markets of all
three Latin American countries peaked in 1994, with the Mexican andArgentinian stock market peaking in January, followed by Brazil in
September. The Mexican stock market crashed first, in December 1994.
The so-called “Tequila effect” next affected Argentina, where local
banks lost one-fifth of their deposits, interest rates increased and net
capital flows turned negative, and the stock market crashed in February
1995. Brazil followed in March 1995.
Recovery Recovery took 22 months for Brazil and 23 months for Argentina. The Mexcian stock market has yet to recover to its pre-crisis
peak.

Crises in developed and emerging stock markets

277

Box 1, continued
The Asian Stock Markets
1. The 1979-80 crisis, involving S. Korea and Thailand, was preceded by
the doubling of the oil price by OPEC in 1979, leading to balance of
payment problems for non-oil producing countries, especially in theemerging market countries. The S. Korean stock market peaked inAugust 1978 and crashed in May 1979. The stock market in Thailand
peaked in October 1978 and crashed in January 1980.
Recovery Recovery was prolonged, lasting five years for Thailand andfive years and one month for S. Korea.
2. The 1990 crisis involved Indonesia, S. Korea, the Philippines, Taiwan
and Thailand. The crisis was preceded by tight monetary conditions,high interest rates and slowing economic growth in many countries, and
the Gulf war in August 1990. For the Asian countries, the crisis was also
a time of political uncertainty, natural disasters and a deterioration of theexternal trade balance for some countries. The five Asian stock markets
in crisis all peaked between March 1989 and July 1990, thanks to international investor interest and gradual economic deregulation. The stock
markets in the Philippines and Taiwan crashed first, in May 1990, followed by S. Korea in August 1990, Thailand in September 1990 and Indonesia in October 1990.
Recovery Thailand recovered in 23 months and the Philippines in 35
months, but the other three stock markets have yet to recover to theirpre-crisis peak levels.
3. The crisis of 1996 involved Indonesia, Korea, Malaysia, the Philippines
and Thailand. Prices in the Thai stock market had increased almost
three times between 1990 and 1994, peaking in October 1994. Subsequently, prices declined over concerns about high interest rates and badbank loans, and the market crashed in October 1996. The Malaysian andPhilippine markets peaked in early 1997 and crashed together in August
1997. The Indonesian and Korean stock markets were holdovers fromthe 1990 crisis.
Recovery Indonesia and Korea have yet to recover from the 1989 crisis.
All five markets remain in crisis at the time of writing.

278

Sandeep Patel and Asani Sarkar

Box 2: Summary of Analysis and Results* Empirical analysis of stock price index data for eight developed and ten
emerging markets from 1970 to 1997.
* Nine stock market crashes over our sample period, three in each region.
* Each developed market crisis has been less severe than the previous one,both in terms of the magnitude of price decline and the duration of thecrisis.
* For emerging markets, prices fall rapidly and steeply, and take long to recover, usually in about three years or less.
* For all markets, prices decline for at least three years subsequent to therecovery from the crisis.
* There is evidence of contagion—most markets in a region participate in
the crisis.
* For U.S. investors with long horizons (one year or more), international
investing is beneficial even during periods of market declines.

1.2

1.0

0.8

0.6

0.4

Developed
Latin America
Asia

0.2
Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
Time

Crises in developed and emerging stock markets

Current index as a proportion of the maximum historical level

Figure 1: Equity market index levels relative to historical maximum for:Developed markets, emerging Latin America, and emerging Asia

279

280

Current index as a proportion of the rolling three-year minimum

Sandeep Patel and Asani Sarkar

Figure 2: Equity market index levels relative to rolling three-year minimum for:Developed markets, emerging Latin America, and emerging Asia
1.2

1.0

0.8

0.6

0.4

0.2
Developed
Latin America
Asia

0.0
Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec- Dec69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
Time

0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6

Dev eloped
Latin America
Asia

-0.8
-1.0
-60

-50

-40

-30

-20

-10

0

10

Leads and Lags

20

30

40

50

60

Crises in developed and emerging stock markets

Correlation between CMINt and CMAXt

Figure 3: Do declines predict increases and increases predict declines?
Correlation between CMINt (rolling three-year minimum relative to current index level) and CMAXt(current index level relative to historical maximum) at various lags and leads

281

282

DECLINE
BEGINNING

CRASH

RECOVERYTROUGH

END

United Kingdom
Italy
FranceCanadaMexicoBrazilTaiw an
Malaysia
Indonesia
Asia
Developed

6912
6912
0

7112
7112
24

7312
7312
48

7512
7512
72

7712
7712
96

7912
7912
120

8112
8112
144

8312
8312
168

8512
8512
192

8712
8712
216

8912
8912
240

9112
9112
264

9312
9312
288

9512
9512
312

9712
9712
336

Sandeep Patel and Asani Sarkar

Figure 4: Individual country and regional crises
Times from the beginning to the end of crises separated into times to identification, trough and recovery

Figure 5: Do U.S. investors’ diversification benefit from international investing change in periodsof low U.S. returns?
Correlation of lowest quarter of U.S. returns for different investment horizons with emerging Asian,
Latin American and developed countries
0.7

Correlation of U.S. and international returns

0.3

0.1

-0.1

Asia
-0.3

Latin America
Developed ex-U.S.,Japan

-0.5
1

6

11

16

Horizon of Investment

21

26

Crises in developed and emerging stock markets

0.5

283

284

Sandeep Patel and Asani Sarkar

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