Transmission of Financial Crises and Contagion

Mardi Dungey: Professor of Economics and Finance, University of TasmaniaRenee A. Fry: Research Associate, Centre for Financial Analysis and PolicyBrenda Gonzalez-Hermosillo: Deputy Division Chief of Global Financial Stability, Monetary and Capital Markets Department, International Monetary FundVance 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

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.