Cross-Border Contagion Risk Transmission Through Stock Markets Channel: The Case of the Baltic Countries

International investors have seen emerging stock markets as the most exciting and promising area for investment, especially because they are expected to generate high returns and to offer good portfolio diversification opportunities. However, the recent global shocks in the major financial centers raise the question about portfolio diversification opportunities during financial turmoil. The objective of this study is to identify the episodes of cross-border contagion risk transmission through stock markets channel in the Baltic countries. Dynamic Conditional Correlation Generalized Autoregressive Conditional Heteroskedasticity (DCC-GARCH) model and Favero and Giavazzi outlier test are used. The results of this empirical study allow to identify some episodes of the cross-border contagion risk transmission through stock markets channel in the Baltic countries, for example, the announcement of the Lehman Brothers bank collapse on 15 September, 2008, etc. The empirical results of this study suggest that despite the low degree of the Baltic stock markets global and regional integration, system-wide shocks in the global financial centers affect the Baltic stock markets. The most significant effect of the cross-border contagion risk transmission was identified in Estonian and Lithuanian stock markets, while the reaction of investors in Latvian stock market was more conservative.