A statistical procedure for testing financial contagion
AbstractThe aim of the paper is to provide an analysis of contagion through the measurement of the risk premia disequilibria dynamics. In order to discriminate among several disequilibrium situations we propose to test contagion on the basis of a two-step procedure: in the first step we estimate the preference parameters of the consumption-based asset pricing model (CCAPM) to control for fundamentals and to measure the equilibrium risk premia in different countries; in the second step we measure the differences among empirical risk premia and equilibrium risk premia in order to test cross-country disequilibrium situations due to contagion. Disequilibrium risk premium measures are modelled by the multivariate DCC-GARCH model including a deterministic crisis variable. The model describes simultaneously the risk premia dynamics due to endogenous amplifications of volatility and to exogenous idiosyncratic shocks (contagion), having controlled for fundamentals effects in the first step. Our approach allows us to achieve two goals: (i) to identify the disequilibria generated by irrational behaviours of the agents, which cause increasing in volatility that is not explained by the economic fundamentals but is endogenous to financial markets, and (ii) to assess the existence of contagion effect defined by exogenous shift in cross-country return correlations during crisis periods. Our results show evidence of contagion from the United States to United Kingdom, Japan, France, and Italy during the financial crisis which started in 2007-08.
F. ALLEN, D. GALE, (2005), Financial intermediaries and markets, “Econometrica”, 72, pp. 1023-1061.
D.W.K. ANDREWS, B. LU, (2001), Consistent model and moment selection procedures for GMM estimation with application to dynamic panel data models, “Journal of Econometrics”, 101, pp. 123-164.
A. ANG, G. BEKAERT, (2002), International asset allocation with regime shifts, “Review of Financial Studies”, 11, pp. 1137-1187.
M. ARTIS, T. OKUBO, (2009), Globalization and business cycle transmission, “The North American Journal of Economics and Finance”, 20, pp. 91-99.
D.K. BACKUS, P.J. KEHOE, (1992), International evidence on the historical properties of business cycles, “The American Economic Review”, 82, pp. 864-888.
D. BERNOULLI, (1954), Exposition of a new theory on the measurement of risk, “Econometrica”, 22, pp. 26-36.
M. BILLIO, L. PELIZZON, (2003), Contagion and interdependence in stock markets: have they been misdiagnosed?, “Journal of Economics and Business”, 55, pp. 405-426.
T. BOLLERSLEV, (1990), Modelling the coherence in short run nominal exchange rates: a multivariate generalized ARCH model, “The Review of Economics and Statistics”, 72, pp. 498-505.
B.H. BOYER, M.S. GIBSON, M. LORETAN, (1999), Pitfalls in tests for changes in correlations, Federal Reserve Board International Finance Discussion Paper no. 597R.
P. BOSSAERTS, (2004), Filtering returns for unspecified biases in priors when testing asset pricing theory, “Review of Economic Studies”, 71, pp. 63-86.
S. CALVO, C. REINHART, (1996), Capital flows to Latin America: is there evidence of contagion effects?, World Bank Policy Research Working Paper Series 1619.
S.G. CECCHETTI, P.S. LAM, N.C. MARK, (2000), Asset pricing with distorted beliefs: are equity returns too good to be true?, “American Economic Review”, 90, pp. 205-251.
T.C. CHIANG, B.N. JEON, H. LI, (2007), Dynamic correlation analysis of financial contagion: evidence from Asian markets, “Journal of International Money and Finance”, 26, pp. 1206-1228.
M. CIPRIANI, A. GUARINO, (2003), Herd behavior and contagion in financial markets, ELSE e-book, Dept. of Economics University College London: http://eprints.ucl.ac.uk/14636/1/14636.pdf.
S. CLAESSENS, R. DORNBUSCH, Y. PARK, (2001), International financial contagion: how it spreads and how it can be stopped, in S. CLAESSENS, K.J. FORBES (eds.), International financial contagion, Kluwer Academic Publishers, Boston.
J.H. COCHRANE, (2001), Asset Pricing, Princeton University Press, Princeton.
V. CORRADI, N.R. SWANSON, (2011), Predictive density construction and accuracy testing with multiple possible misspecified diffusion models, “Journal of Econometrics”, 161, pp. 304-324.
G. CORSETTI, M. PERICOLI, M. SBRACIA, (2001), Correlation analysis of financial contagion: what one should know before running a test, Economic Working Papers, 408, Bank of Italy.
G. CORSETTI, M. PERICOLI, M. SBRACIA, (2005), Some contagion, some interdependence: more pitfalls in tests of financial contagion, “Journal of International Money and Finance”, 24, pp. 1177-1199.
M.J. CRUCINI, M.A. KOSE, C. OTROK, (2011), What are the driving forces of international business cycles?, “Review of Economic Dynamics”, 14, pp. 156-175.
A. DAMODARAN, (2010), Equity risk premium: determinants, estimation and implications, Stern School of Business, New York.
M. DUNGEY, R. FRY, B. GONZÁLEZ-HERMOSILLO, V. MARTIN, (2004), Empirical modeling of contagion: a review of methodologies. IMF Working Papers, 04/78.
S. EDWARD, (2000), Interest rates, contagion and capital control, National Bureau of Economic Research, Working Paper 7801.
R.F. ENGLE, (2002), Dynamic conditional correlation: a simple class of multivariate GARCH models, “Journal of Business & Economic Statistics”, 20, pp. 339-350.
R.F. ENGLE, K. SHEPPARD, (2001), Theoretical and empirical properties of dynamic conditional correlation multivariate GARCH, mimeo, University of California, San Diego.
K.J. FORBES, R. RIGOBON, (2001), Measuring contagion: conceptual and empirical issues, in S. CLAESSENS,
K.J. FORBES (eds.), International financial contagion, Kluwer Academic Publishers, Boston.
K.J. FORBES, R. RIGOBON, (2002), No contagion, only interdependence: measuring stock market comovements, “Journal of Finance”, 57, pp. 2223-2262.
L.P. HANSEN, T.J. SARGENT, (2006), Fragile beliefs and the price of model uncertainty, Working Paper, New York University and University of Chicago.
L.P. HANSEN, K.J. SINGLETON, (1982), Generalized instrumental variables estimation of nonlinear rational expectations models, “Econometrica”, 50, pp. 1269-1286.
D. KAHNEMAN, A. TVERSKY, (1979), Prospect theory: an analysis of decision under risk, “Econometrica”, 47, pp. 263-292.
F.H. KNIGHT, (1921), Risk, uncertainty, and profit, Houghton Mifflin, Boston.
A.M. KOSE, C. OTROK, C.H. WHITEMAN, (2008), Understanding the evolution of world business cycles, “Journal of International Economics”, 75, pp. 110-130.
A. KRISHNAMURTHY, (2009), Amplification mechanism in liquidity crises, National Bureau of Economic Research, Working Paper 15040.
M. KURTZ, A. BELTRATTI, (1997), The equity premium is no puzzle, Springer, New York.
F. LONGIN, B. SOLNIK, (1995), Is the correlation in international equity returns constant: 1960-1990?, “Journal of International Money and Finance”, 14, pp. 3-26.
F. LONGIN, B. SOLNIK, (2001), Extreme correlations in international equity markets, “Journal of Finance”, 56, pp. 649-676.
P. MASSON, (1999a), Contagion: monsoonal effects, spillovers, and jumps between multiple equilibria, in
P.R. AGÉNOR, M. MILLER, D. VINES, A. WEBER (eds.), The Asian financial crisis: causes, contagion and consequences, Cambridge University Press.
P. MASSON, (1999b). Contagion: macroeconomic models with multiple equilibria, “Journal of International
Money and Finance”, 18, pp. 587-602.
R. MEHRA, E.C. PRESCOTT, (1985), The equity premium: a puzzle, “Journal of Monetary Economics”, 15, pp. 145-161.
H. MUMTAZ, S. SIMONELLI, P. SURICO, (2011), International comovements, business cycle and inflation: A historical perspective, “Review of Economic Dynamics”, 14, pp. 176-198.
M. PERICOLI, M. SBRACIA, (2001), A primer on financial contagion, “Journal of Economic Surveys”, 17, pp. 571-608.
M. PRITSKER, (2000), The channels of financial contagion, in S. CLAESSENS, K.J. FORBES (eds.), International financial contagion, Kluwer Academic Publishers, Boston. R.G. RAJAN, (2010), Fault lines: how hidden fractures still threaten the world economy, Princeton University Press, Princeton.
J.C. RODRIGUEZ, (2007), Measuring financial contagion: a copula approach, “Journal of Empirical Finance”, 14, pp. 401-423.
R. SHILLER, (1981), Do stock prices move too much to be justified by subsequent changes in dividends?, “The American Economic Review”, 71, pp. 421-436.
H.S. SHIN, (2008), Risk and liquidity, Clarendon Lectures in Finance, Oxford University Press, Oxford.
M.N. SYLLIGNAKISA, G.P. KOURETAS, (2011), Dynamic correlation analysis of financial contagion: evidence from the Central and Eastern European markets. “International Review of Economics & Finance”, 20, pp. 717-732.
J.H STOCK, J.H. WRIGHT, (2000), GMM with weak identification, “Econometrica”, 68, pp. 1055-1096.
Y. SUGIHARA, (2010), The model free implied volatility in Nikkei 225 stock index options, “Monetary and Economic Studies”, 29, pp. 73-120.
A.G. TIMMERMAN, (1996), Excess volatility and predictability of stock prices in autoregressive dividend models with learnings, “Review of Economic Studies”, 63, pp. 523-557.
J. VON NEUMANN, O. MORGENSTERN, (1944), Theory of games and economic behavior, Princeton University Press, Princeton.
How to Cite
Copyright (c) 2012 Statistica
This work is licensed under a Creative Commons Attribution 3.0 Unported License.