Kristin J. Forbes

No Contagion, Only Interdependence: Measuring Stock Market Comovements

This paper examines stock market co-movements. It begins with a discussion of several conceptual issues involved in measuring these movements and how to test for contagion. Standard tests examine if cross-market correlation in stock market returns increase during a period of crisis. The measure of cross-market correlations central to this standard analysis, however, is biased. The unadjusted correlation coefficient is conditional on market movements over the time period under consideration, so that during a period of turmoil when stock market volatility increases, standard estimates of cross-market correlations will be biased upward. It is straightforward to adjust the correlation coefficient to correct for this bias. The remainder of the paper applies these concepts to test for stock market contagion during the 1997 East Asian crises, the 1994 Mexican peso collapse, and the 1987 U.S. stock market crash. In each of these cases, tests based on the unadjusted correlation coefficients find evidence of contagion in several countries, while tests based on the adjusted coefficients find virtually no contagion. This suggests that high market co-movements during these periods were a continuation of strong cross-market linkages. In other words, during these three crises there was no contagion, only interdependence.

Measuring Contagion: Conceptual and Empirical Issues

The 1990’s has been punctuated by a series of severe financial and currency crises: the Exchange Rate Mechanism (ERM) attacks of 1992; the Mexican peso collapse of 1994; the East Asian crisis of 1997; the Russian collapse of 1998; and the Brazilian devaluation of 1999. One striking characteristic of several of these crises was how an initial country-specific shock was rapidly transmitted to markets of very different sizes and structures around the globe. This has prompted a surge of interest in “contagion”.

International Financial Contagion

Preface. Acknowledgments. Contributors. Part I: Overview: The Theory and Empirics of Contagion. 1. International Financial Contagion: An Overview of the Issues and the Book S. Claessens, K. Forbes. 2. Contagion: Why Crises Spread and How This Can Be Stopped S. Claessens, et al. 3. Measuring Contagion: Conceptual and Empirical Issues K. Forbes, R. Rigobon. 4. The Channels for Financial Contagion M. Pritsker. Part II: Specific Mechanisms Driving Contagion. 5. Crisis Transmission: Evidence from the Debt, Tequila and Asian Flu Crises J. de Gregorio, R. Valdes. 6. Flight to Quality: Investor Risk Tolerance and the Spread of Emerging Market Crises B. Eichengreen, et al. 7. Mutual Fund Investment in Emerging Markets: An Overview G. Kaminsky, et al. 8. Portfolio Diversification, Leverage, and Financial Contagion G. Schinasi, T. Smith. Part III: Case Studies of Contagion. 9. Thai Meltdown and Transmission of Recession within the ASEAN4 and NIE4 T. Abeysinghe. 10. Financial Contagion in the East Asian Crisis: With Special Reference to the Republic of Korea Y.C. Park, C.-Y. Song. 11. The Russian Default and the Contagion to Brazil T. Baig, I. Goldfajn. 12. Contagion of International Financial Crises: The Case of Mexico S. Bazdresch, A. Werner. 13. Financial Market Spillovers: How Different are the Transition Economies? G. Gelos, R. Sahay. 14. Are Financial Crises Becoming More Contagious?: What is the Historical Evidence on Contagion? M. Bordo, A. Murshid. Part IV:Implications for Policy and the International Financial Architecture. 15. International Contagion: Implications for Policy R. Chang, G. Majnoni. 16. International Financial Reform: Regulatory and Other Issues J. Hawkins, P. Turner. Part V: Original Conference Program.

A Decomposition of Global Linkages in Financial Markets Over Time

This paper tests if real and financial linkages between countries can explain why movements in the worlds largest markets often have such large effects on other financial markets, and how these cross-market linkages have changed over time. It estimates a factor model in which a countrys market returns are determined by: global, sectoral, and cross-country factors (returns in large financial markets), and country-specific effects. Then it uses a new data set on bilateral linkages between the worlds 5 largest economies and about 40 other markets to decompose the cross-country factor loadings into: direct trade flows, competition in third markets, bank lending, and foreign direct investment. Estimates suggest that both cross-country and sectoral factors are important determinants of stock and bond returns, and that the U.S. factor has recently gained importance, while the Japanese and U.K. factors have lost importance. From 1996-2000, real and financial linkages became more important determinants of how shocks are transmitted from large economies to other markets. In particular, bilateral trade flows are large and significant determinants of cross-country linkages in both stock and bond markets. Bilateral foreign investment is usually insignificant. Therefore, despite the recent growth in global financial flows, direct trade still appears to be the most important determinant of how movements in the worlds largest markets affect financial markets around the globe.

One Cost of the Chilean Capital Controls: Increased Financial Constraints for Smaller Traded Firms

There is growing support for taxes on short-term capital inflows in emerging markets, such as the encaje adopted by Chile from 1991-98. Previous empirical assessments of the encaje conclude that it may have generated some small economic benefits, such as shifting the composition of capital inflows to a longer maturity, but no significant economic costs. Managers of small and medium-sized companies in Chile, however, claim that the encaje made it substantially more difficult to obtain financing for productive investment. This paper assesses whether the Chilean capital controls increased financial constraints for different-sized, publicly-traded firms. It uses two different testing methodologies: a Tobins q and Euler-equation framework. Results indicate that during the encaje, smaller traded firms in Chile experienced significant financial constraints and these constraints decreased as firm size increased. Both before and after the encaje, however, no group of traded firms experienced significant financial constraints, and there is no relationship between firm size and financial constraints. Although Chilean-style capital controls may also yield benefits encaje could be particularly important in emerging markets where smaller firms can be valuable sources of job creation and economic growth.

The Asian flu and Russian virus: the international transmission of crises in firm-level data

Abstract This paper examines how the Asian and Russian crises affected different types of firms around the world. It constructs a new data set of financial statistics, industry information, geographic data, and stock returns for over 10 000 companies in 46 countries. Results show that firms competing with exports from the crisis countries, or with direct sales exposure to the crisis countries, had significantly lower abnormal stock returns. Firms with higher debt ratios, however, did not experience lower abnormal returns. Country-specific effects, although important determinants of company stock returns, are generally less important than firm-specific characteristics. These results suggest that trade channels are important factors determining how crises are transmitted internationally.

Why do foreigners invest in the United States

Why are foreigners willing to invest over

Capital Controls and Macroprudential Measures: What Are They Good For?

2Â trillion per year in the United States? This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries that trade more with the United States also have greater portfolio shares in U.S. equity and bond markets. These results support recent theoretical work on the role of financial development in sustaining global imbalances and have important implications for whether the United States can continue to attract sufficient financing from abroad without major changes in asset prices and returns, especially in bond markets.

Skill classification does matter: estimating the relationship between trade flows and wage inequality

Are capital controls and macroprudential measures successful in achieving their objectives? Assessing their effectiveness is complicated by selection bias and endogeneity; countries which change their capital-flow management measures (CFMs) often share specific characteristics and are responding to changes in variables that the CFMs are intended to influence. This paper addresses these challenges by using a propensity-score matching methodology. We also create a new database with detailed information on weekly changes in controls on capital inflows, capital outflows, and macroprudential measures from 2009 to 2011 for 60 countries. Results show that macroprudential measures can significantly reduce some measures of financial fragility. Most CFMs do not significantly affect other key targets, however, such as exchange rates, capital flows, interest-rate differentials, inflation, equity indices, and different volatilities. One exception is that removing controls on capital outflows may reduce real exchange rate appreciation. Therefore, certain CFMs can be effective in accomplishing specific goals—but most popular measures are not “good for” accomplishing their stated aims.

International Financial Contagion: An Overview of the Issues and the Book

Empirical work must pay careful attention to how it measures the relative skill abundance of countries and the relative skill intensity embodied in trade flows. This paper compiles a new data set, using income levels, average education, manufacturing wages, and an index of these three variables, to classify countries and trade flows as relatively high skill or low skill. Then, in order to show the importance of skill classification, it uses a reduced-form fixed-effects model to estimate the relationship between trade flows and wage inequality. This specification not only controls for any time-invariant omitted variables, but also permits the inclusion of a large number of diverse countries. When more accurate skill rankings are utilized, results suggest that, in high-skill abundant countries, increased trade with lower-skill countries is correlated with an increase in wage inequality. This relationship is significant and highly robust and is driven by the negative relationship between trade and low-skill wages (instead of a positive relationship between trade and high-skill wages.) Results, however, are highly dependent on the skill classification utilized.