Contagion effect of the European financial crisis on China's stock markets: Interdependence and pure contagion

This paper examines the contagion effect of the European debt crisis on China's stock market. The analysis tests pure contagion effects and interdependence by utilizing the Kalman filter approach to estimate the time-varying correlation coefficients of the stock market indices between the Eurozone and China. The empirical results indicate that after controlling the macro fundamental variables and global shocks, the crisis contagion's effect on investors' psychology in the Chinese capital market is limited. The result of variance analysis demonstrates that macroeconomic variables have played a major role in stock market between China and the Eurozone. The model provides a mechanism for tracing the time varying correlation coefficients in a structured way after controlling the fundamental variables and global shocks and can reflect the changing market dynamics accurately. •We examine the contagion effect of European debt crisis on China's stock market.•Kalman filter approach is used to control macroeconomic variables and global shocks.•We find that the pure contagion effect on investors' psychology is limited.•The interdependence on the macroeconomic channel is significant.