Renée Fry

Empirical Modelling of Contagion: A Review of Methodologies

The existing literature promotes a number of alternative methods to test for the presence of contagion during financial market crises. This paper reviews those methods, and shows how they are related in a unified framework. A number of extensions are also suggested which allow for multivarite testing, endogeneity issues and structural breaks.

ARE FINANCIAL CRISES ALIKE

This paper investigates whether financial crises are alike by considering whether a single modeling framework can fit multiple distinct crises in which contagion effects link markets across national borders and asset classes. The crises considered are Russia and LTCM in the second half of 1998, Brazil in early 1999, dot-com in 2000, Argentina in 2001-2005, and the recent U.S. subprime mortgage and credit crisis in 2007. Using daily stock and bond returns on emerging and developed markets from 1998 to 2007, the empirical results show that financial crises are indeed alike, as all linkages are statistically important across all crises. However, the strength of these linkages does vary across crises. Contagion channels are widespread during the Russian/LTCM crisis, are less important during subsequent crises until the subprime crisis, where again the transmission of contagion becomes rampant.

Correlation, Contagion, and Asian Evidence*

This paper examines the empirical literature on financial market contagion in Asia during the 199798 financial crises with respect to existing tests of contagion. Empirical evidence shows that contagion affects both developed and emerging markets and does not seem to vary with the relative fundamental economic health or trade and financial linkages of the Asian economies. Contagion occurs across both asset types and geographical borders and tends to have larger effects in equity markets than in currency and bond markets. There is evidence to support the hypothesis that contagion is regional and transmitted through developed markets. A discussion of the behavior of correlation coefficients in the presence of contagion and financial crises suggests that they are not a reliable metric for detecting contagion.

Unanticipated Shocks and Systemic Influences: The Impact of Contagion in Global Equity Markets in 1998

August to September 1998 has been characterized as one of the worst episodes of global financial distress in decades. This paper investigates the transmission of the Russian and the LTCM crises through global equity markets using a panel of 14 developing and industrial countries. The results show that contagion was systemic during the period, with industrial countries providing the dominant cross-country transmission linkages. Both crises reinforced each other, highlighting the importance of studying them jointly. An implication of the empirical results is that models of contagion that exclude industrial countries are potentially misspecified and may yield misleading outcomes.

Equity Transmission Mechanisms from Asia to Australia: Interdependence or Contagion?

The linkages between daily Asian and Australian equity market returns over the period 1995–2001 are investigated within the framework of a latent factor model. Transmission mechanisms arising from both market interdependence and contagion are studied. The empirical results reveal that co-movements in Asian and Australian equity markets are largely determined by interdependent linkages arising from common systemic factors. There is little significant evidence of contagion, although negative shocks have more effect than positive ones.

Overvaluation in Australian Housing and Equity Markets: Wealth Effects or Monetary Policy?

A structural vector autoregression model is used to identify overvaluation in house prices in Australia from 2002 to 2008. An important feature is the development of a housing sector where long-run restrictions are derived from theory to identify housing demand and supply shocks. The results show strong evidence of overvaluation in real house prices, reaching a peak of just over 15 per cent by the end of 2003. Factors driving overvaluation are housing demand shocks before 2006 and post-2006 macroeconomic shocks. Wealth effects from equity markets are also important. The results suggest that monetary policy is not an important contributor to overvaluation of house prices.

Characterizing Global Investors' Risk Appetite for Emerging Market Debt During Financial Crises

The effects of unanticipated movements in global risk on nine emerging bond markets are investigated. The components of global risk are volatility, credit, and liquidity risks. Country and contagion risks are also studied individually. A historical decomposition of bond spreads is used to identify the relative contributions of risk during 1998-99. The empirical results show that the Russian/LTCM crises were characterized by increases in global credit risk, while the relative size of global risk factors was mixed for the Brazilian crisis, with no component dominating. Country risk is found to be important for all countries, while there is little evidence of contagion risk.

International Shocks on Australia - the Japanese Effect

Although Australia has an equivalently large trading relationship with Japan and the US, current macro models often incorporate only US variables in the external sector of Australia. This paper explores the consequences of including both US and Japanese effects in the international sector of a SVAR model of Australia. The results indicate the significance of the Japanese effects. Excluding Japan results in an overstatement of the impact of US based shocks on the Australian economy. When Japan is included, US based shocks remain dominant in explaining Australian outcomes, but the responses are moderated compared with a model incorporating only a US based external sector. This has important implications for domestic policy responses to international shocks. Without the influence of Japan, domestic monetary policy will over-react to a US based shock.

Actually this Time is Different

Episodes of extraordinary turbulence in global financial markets are examined during eight crises ranging from Asia in 1997-98 to the recent great recession of 2008-10. The analysis focuses on changes in the dependence structures of equity markets through correlation and coskewness to answer the question of whether the great recession is different to other crises in terms of shock transmission through contagion. The results show that ‘this time is different’ and that the great recession is truly a global financial crisis. Other US sourced crises do not affect other markets through contagion, and emerging market crises transmit unexpectedly.

The role of portfolio shocks in a structural vector autoregressive model of the Australian economy

Domestic and foreign equity shocks on the Australian economy are analysed within a five-variate structural vector autoregressive model, with identification achieved through long-run restrictions based on the natural rate hypothesis, monetary neutrality, long-run portfolio balance and purchasing power parity. The results show that real equity values were undervalued by 19 per cent by June 2005, with the gap narrowing thereafter. Foreign crises are important factors explaining this deterioration. The real wealth effects of equity market shocks impact significantly upon financial and goods market prices, whereas output tends to be immune. The model is also able to address puzzles that exist in the vector autoregression literature. Copyright