Transmission of Financial Crises and Contagion

• Provides a thorough review of the methods developed by the authors for measuring the effects of contagion during financial crises. No other existing work measures the extent of contagion effects beyond simply detecting its existence. Code for implementation is available

Readership: Graduate students, academics, central banks. Advanced courses in financial econometrics.

Mardi Dungey, Professor of Economics and Finance, University of Tasmania, Renee A. Fry, Research Associate, Centre for Financial Analysis and Policy, Brenda Gonzalez-Hermosillo, Deputy Division Chief of Global Financial Stabilit, International Monetary Fund, and Vance L. Martin, Professor of Econometrics, University of Melbourne

Preface vii
Acknowledgements ix
1 Introduction 1
2 Review of the Empirical Literature 7
2.1 Introduction 7
2.2 Defining Contagion 8
2.3 AModel of Interdependence . 10
2.4 An EmpiricalModel of Contagion 12
2.4.1 Bivariate Testing . 13
2.4.2 Multivariate Testing . 15
2.4.3 Structural Breaks . 16
2.4.4 Using Just CrisisData 17
2.4.5 Autoregressive and HeteroskedasticDynamics . 17
2.5 Correlation and Covariance Analysis 19
2.5.1 Bivariate Testing . 20
2.5.2 Alternative Formulation . 22
2.5.3 Multivariate Testing . 24
2.5.4 Endogeneity Issues 27
2.5.5 Relationship withOtherModels . 29
2.6 Application 33
2.6.1 Stylized Facts . 34
2.6.2 Implementation Issues 34
2.6.3 Contagion Testing 36
2.7 Conclusions 38
3 Contagion in Global Bond Markets 41
3.1 Introduction 41
3.2 Background of Events and Propositions . 43
3.2.1 Stylized Facts . 43
3.2.2 Propositions 45
3.3 Data 47
3.4 AFactorModel of Bond Spreads 48
3.5 EstimationMethod 54
3.6 Empirical Results . 56
3.7 Conclusion . 59
3.A Data Definitions and Sources 62
3.B Descriptive Statistics . 62
3.C Unit Root Tests 62
3.D EstimatedGARCHModels 63
4 Contagion in Global Equity Markets 65
4.1 Introduction 65
4.2 AModel of Financial Turmoil 66
4.2.1 ABenchmarkModel . 67
4.2.2 AModel Incorporating Contagion 69
4.3 Empirical Issues 72
4.3.1 Data 72
4.3.2 GMMEstimator . 74
4.4 Empirical Results . 75
4.4.1 Parameter Estimates . 75
4.4.2 Volatility Decompositions 77
4.4.3 Structural Break Tests 78
4.4.4 Robustness Checks 78
4.4.5 Comparison with BondMarket Transmissions . 79
4.5 Conclusions 80
5 Are Crises Alike? 83
5.1 Introduction 83
5.2 AModel of Contagion 85
5.3 Empirical Factor Specification 89
5.3.1 Noncrisis Specification 90
5.3.2 Crisis Specification 91
5.4 Data 95
5.4.1 Filters . 96
5.4.2 CrisisDates 97
5.5 Empirical Results . 99
5.5.1 Evidence of Contagion 100
5.5.2 Comparison of Contagion Channels Across Crises . 103
5.5.3 Testing the Channels of Contagion . 104
5.6 Robustness Checks andAdditional Tests 105
5.6.1 CrisisDating SensitivityAnalysis 105
5.6.2 ConditionalMoment Tests 107
5.6.3 Structural Break Tests 107
5.7 Conclusions 108
5.A Model Derivations . 111
5.A.1 Optimal PortfolioWeights 111
5.A.2 Informed Conditional Expectations . 112
5.A.3 Uninformed Conditional Expectations 113
5.A.4 Excess Returns Equation . 115
5.B Data Sources and Definitions 118
5.C Additional VarianceDecompositions 118
6 Characterizing Global Risk 119
6.1 Introduction 119
6.2 AModel of Risk Premia . 121
6.2.1 Model Specification 122
6.2.2 Identifying RiskQuantities 124
6.2.3 Estimation . 126
6.3 Empirical Estimates . 126
6.3.1 RiskQuantities 126
6.3.2 Risk Prices 128
6.4 Historical Decomposition of Risk Premia 129
6.4.1 Benchmark Spread Estimates 130
6.4.2 Global Risk Factor Estimates 130
6.4.3 Country Risk Factor Estimates . 131
6.4.4 ContagionRisk Factor Estimates 132
6.5 Conclusions 132
6.A Data Definitions and Sources 134
6.B CrisisDates 134
7 Conclusions Bibliography