What does it take to have a contagion event?

There has been more talk about the lack of contagion over Greece as well as the lack of a spill-over from the decline of the Chinese stock market. The term contagion has been thrown around with respect to these events, but it is not clear why some events will lead to a contagion and others will not. We will focus on global macro contagion which will be events that can spill-over across markets and affect global risk-taking. Here is a list of what is may be necessary for a contagion across markets:

1. Sizable - For a contagion to exist there has to be a market problem that will be large and effect a broad set of market participants. The Greek crisis is sizable, but not for private investors given most have sold their bonds. The size of Greece is small versus many other economies.
2. Connectedness - An event that leads to contagion has to be connected across markets and market participants. In the case of Greece, the impact has to affect all of the EMU and beyond. China is not as connected  as other stock markets because foreign investors are a small part of the market.
3. Surprise/shock - The event that starts the contagion has to be a surprise to the market. The Greek referendum was a shock to most market participants. The sharp decline in China equities was also a market surprise. There was a strong element of surprise.
4. Emotional - The event has to play on emotions or can be visual. The long lines at Greek ATM's is emotional. The chart decline for China equities is emotional. As they say in news, "If it bleeds, it leads."
5. Suggestible - The event has to be connected to other around the globe, but also has to have suggestibility as to a greater threat  to the markets. If there is a Greek crisis, it suggests that there will carry-over to other countries.
6. Leverage - Without a doubt, leverage is the gasoline that will drive any crisis fire. Margin lending in China makes the market decline a bigger event than normal. Levered real estate loans is what made the housing crisis worse than expected.
7. Homogeneity of balance sheet and expectations - To get the contagion to take hold, there has to be a large number of market participants having the same position and expectations before the surprise event. The market is tilted in one direction and there is a catalyst that switches or changes expectations.
8. Cascades and liquidity shortage - The shift in expectations leads to cascades of behavior. There is herding. A negative market event creates an environment where others will follow the shift and start selling waves. Markets become one-sided with a shortage of liquidity because everyone is thinking the same.
9. Vulnerabilities - The contagion will have a stronger impact if the firms are vulnerable to the shock. The size of their positions could be large. The size of loses could have an measurable impact on performance.
10. Cheap money - Leverage only occurs because there is cheap money available, so for any crisis there has to be cheap money that causes market participants to reach for return relative to risk.

All of these should not be given the same weight and their is not a specific order to our list, but most should be present to have a significant contagion event. These are not easily quantifiable except for what may be most important, leverage and cheap money. When there are the two, there will be the chance for a crisis to take hold.