Is the fall in US markets a case of Euro to US Contagion?

[phk]

http://www.google.com/finance?chdnp=1&chfdeh=0&chdet=1273181800662&chddm=1173&cmpto=INDEXDJX:.DJI;INDEXSP:.INX;INDEXNASDAQ:.IXIC&cmptdms=0;0;0&q=INDEXDJX:.DJI,INDEXSP:.INX,INDEXNASDAQ:.IXIC&ntsp=0







I understand that European stock markets should experience re-pricing in response to the uncertainty surrounding sovereign debt. Higher interest rates should induce lower equity prices, in line with standard asset pricing models (simplified example here).

In addition, I know there's a lot of academic research documenting the linkages between stock markets (see Engle, Ito and Lin (Econometrica, 1990) on "meteor showers and heat waves").

Nonetheless, the sharp downward spike in US equity indices, and then upward rebound, doesn't make sense. In addition, with the flight to safety in US Treasuries, you'd think that the US equity market would have enjoyed support.

Here's a choice quote from Bloomberg:

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So maybe the explanation is in the word "panic".

On the other hand, a downward revision in the level of US equity prices (but not necessarily as big 9% as in one point for the Nasdaq), does seem reasonable. Higher interest rates and higher uncertainty, slower -- if not stagnant -- GDP growth, are all negatives for the US. We should expect some impact. How much? Some of the answers are in this paper (coauthored with Kristin Forbes), in which we identify the determinants of the linkages between financial asset markets.

Update, 1pm Pacific: Reuters presents some "instant views". This quote resonates:

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Links: http://www.ssc.wisc.edu/~mchinn/forbes_chinn_REStat.pdf
http://www.terry.uga.edu/~last/classes/8130/readings/engle_ito_lin.pdf

[Free Trade is managed by the invisible hand.]

carmen reinhart Thinks this whole debt restructuring issue could last as long as 5 years before the whole thing is finally finished.