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Details
- 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
Financial crises often transmit across geographical borders and different asset classes. Modelling these interactions is empirically challenging, and many of the proposed methods give different results when applied to the same data sets. In this book the authors set out their work on a general framework for modeling the transmission of financial crises using latent factor models. They show how their framework encompasses a number of other empirical contagion models and why the results between the models differ. The book builds a framework which begins from considering contagion in the bond markets during 1997-1998 across a number of countries and culminates in a model which encompasses multiple assets across multiple countries through over a decade of crisis events from East Asia in 1997-1998 to the sub prime crisis during 2008. Program code to support implementation of similar models is available.
Readership: Graduate students, academics, central banks. Advanced courses in financial econometrics.
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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
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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
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"Examining the role of contagion during financial crisis is an important and difficult task. This book provides a coherent framework for identification, estimation and testing for the presence of contagion. The importance of the framework is illustrated by a number of applications to many recent finiancial crises. I highly recommend it for students, practitioners and scholars interested in linkages between asset markets."--Carlo A. Favero, Professor of Financial Econometrics, Bocconi University
"Policymakers, observers and academics are still struggling to grasp how developments in one particular country (the United States) and one specific, rather narrow market segment (the subprime mortgage market) could turn in 2007-09 into the worst global financial meltdown since the Great Depression. The book makes an important contribution to our understanding of the underlying transmission mechanism that has turned so many individual, isolated events over the past decades into systemic crises. It does so by developing a powerful and elegant conceptual framework, and by illustrating how this framework helps trace the contagious spread of crises. The book could not be more timely and stresses the need for policy cooperation at the global level, and for policymakers to better take into account the rising global interconnectedness when taking decisions."--Marcel Fratzscher, Head of International Policy Analysis Division, European Central Bank
"Despite the large and growing research on financial crises and spillovers, there was much confusion about empirical modeling and testing of links across financial markets. Not anymore. This book presents a new coherent framework for testing and quantifying contagion. At the core of this new framework is the use of latent factor techniques. I highly recommend reading chapter 2 for interpreting, in a new light, previous results in the literature as well as new extensions to deal with structural breaks and endogeneity issues. The case studies throughout the book are very helpful in illustrating the techniques. This is a great book. In the midst of the Subprime-Euro-Greek crisis, this book is a must read."--Graciela L. Kaminsky, Professor of Economics and International Affairs, George Washington University
