When financial crises strike, stock markets thousands of miles apart can suddenly begin moving almost in unison. New research suggests that beneath the apparent chaos lies a web of connections that grows stronger during periods of global turmoil.

Published in the Journal of Risk and Financial Management, the study by Dr Domenico Vicinanza of Anglia Ruskin University (ARU) in Cambridge, England, examined how major American and European stock markets responded to the Global Financial Crisis and the early stages of the Covid-19 pandemic.

Using a technique derived from chaos theory called convergent cross-mapping, researchers analysed the Dow Jones Industrial Average, S&P 500, FTSE 100 and Germany’s DAX before, during and after both crises. Rather than simply measuring whether markets moved together, the technique investigated whether movements in one market carried information about another.

The findings revealed that connections between markets strengthened significantly during both crises, suggesting that financial turmoil does more than trigger falling share prices. It also changes how markets interact, making them increasingly sensitive to shared global pressures.

The effect was particularly pronounced during the Covid-19 pandemic, when every market relationship examined showed stronger connections. The study recorded a 16% increase in average market coupling, with the strongest links between American and European markets emerging within just three trading days.

However, the two crises followed different patterns. While the pandemic triggered a sudden but relatively brief surge in interconnectedness, the Global Financial Crisis produced more persistent connections that continued strengthening even after the initial crisis period. American markets also appeared to exert slightly greater influence on European markets during the pandemic.

Dr Vicinanza, Associate Professor of Intelligent Systems and Data Science at ARU, said chaos theory offers a fresh perspective on financial behaviour by revealing hidden relationships that conventional measures of correlation and volatility may overlook.

He compared the process to discovering footprints in the sand. Although the person who made them may no longer be visible, the footprints reveal their presence. Similarly, patterns within one financial market can provide clues about the behaviour of another, exposing connections that might otherwise remain hidden.

These findings have important implications for investors and financial institutions. When markets become tightly connected, shocks can spread more rapidly across borders, reducing the protection traditionally offered by diversifying investments across different countries. Risk management strategies may therefore need to consider not only individual market volatility but also how interconnected markets become during crises.

“During the Covid-19 crisis in particular, the major US and European markets behaved less like separate markets and more like parts of a single, tightly connected global system,” said Dr Vicinanza. The findings suggest that understanding these shifting relationships could help investors and policymakers better anticipate how financial shocks spread through global markets.

More information: Domenico Vicinanza, Nonlinear Market Coupling During COVID-19 and the Global Financial Crisis: A Convergent Cross-Mapping Analysis of US and European Equity Indices, Journal of Risk and Financial Management. DOI: 10.3390/jrfm19080558

Journal information: Journal of Risk and Financial Management Provided by Anglia Ruskin University