Vance L. Martin

A New Class of Tests of Contagion With Applications

A new class of tests of contagion is proposed identifying transmission channels of financial market crises through changes in higher order moments of the distribution of returns such as coskewness. Applying the framework to test for contagion in real estate and equity markets following the Hong Kong crisis in 1997–1998 and the U.S. subprime crisis in 2007 shows that the coskewness-based tests of contagion detect additional channels not identified by the correlation-based tests. Implications of contagion in pricing exchange options where there is a change in higher order comoments of returns on the underlying assets are also investigated.

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.

Robust Estimation, Nonnormalities, and Generalized Exponential Distributions

The detection and treatment of outliers in data has represented an important area of research. The general approach that has been adopted involves observing that outliers contribute to the “fatness” in the tails of the error distribution and using an appropriate model of the error term to take this into account. This article introduces a general dass of distributions to capture nonnormalities in the data based on the generalized exponential family. This family of distributions provides great flexibility in modeling not only Symmetrie fat-tailed distributions, but also skewed and possibly even multimodal distributions. The approach taken is to use subordinate distributions within the generalized exponential family to model the empirical distribution. This family represents a generalization of the unimodal exponential family, which contains as subordinates the normal, gamma, beta, Student t, and so forth. The parameters of the generalized exponential distribution can be estimated using maximum likelihood, w...

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.

A Multifactor Model of Exchange Rates with Unanticipated Shocks: Measuring Contagion in the East Asian Currency Crisis

A multifactor model of exchange rates is proposed which allows for both time-dependent common and idiosyncratic factors, as well as unanticipated shocks across currency markets. This latter feature of the model is exploited in the empirical application to measure the contribution of contagion to the volatilities of exchange rates during the East Asian currency crisis. The empirical results show evidence of significant contagion. The contribution of contagion is estimated at 9 per cent of total volatility for the Thai baht and 46 per cent for the South Korean won. Indonesia is found to be the most affected in terms of basis points.

On the efficacy of simulated maximum likelihood for estimating the parameters of stochastic differential Equations

A method for estimating the parameters of stochastic differential equations (SDEs) by simulated maximum likelihood is presented. This method is feasible whenever the underlying SDE is a Markov process. Estimates are compared to those generated by indirect inference, discrete and exact maximum likelihood. The technique is illustrated with reference to a one-factor model of the term structure of interest rates using 3-month US Treasury Bill data.

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.

Indirect estimation of ARFIMA and VARFIMA models

Indirect estimation methods are proposed for estimating univariate ARFIMA , as well as more complex multivariate VARFIMA models. Special attention is given to comparing the finite sampling properties of the indirect estimator with Sowells (1992a) exact time domain maximum likelihood estimator and the Geweke and Porter-Hudak (1983) spectral regression estimator.

Monetary Policy Shocks and Security Market Responses

An old and unanswered question is: how does monetary policy work? This paper contributes to a growing recent literature that tries to quantify the first step of the process. These studies use daily data to estimate the response of security prices-bond yields and equity returns - to exogenous monetary policy surprises. We extend the literature in three directions: (1) theory: we specify a general factor model in which security prices respond to multiple sources of systematic risk - monetary policy surprises and other market wide information shocks - and idiosyncratic risk. (2) Empirical: we use all of the daily data while other studies use a small sub-sample of less than 10% of the data. And (3) econometric: we estimate a vector model and impose the over-identifying restrictions. Our empirical results show that efficiently estimating a more general model leads to economically important differences. Our results solve a puzzle and highlight an important neglected short-run channel of monetary policy. Cochrane and Piazzesi (2002), the latest of many, found that long maturity bond yields increase in response to a surprise tightening in monetary policy - a result they properly label a puzzle. Our results eliminate the puzzle. The yield curve response to a monetary surprise displays the classical textbook pattern - short maturity yields rise and long maturity yields do nothing. Common information shocks have a level effect on the yield curve - all yields increase in response to a positive shock. We also find that the equity market, which is ignored in most studies and textbooks, is quantitatively the most important channel for monetary policy in the short run. The wealth effect from a monetary surprise in the equity market dwarfs the wealth effect in debt markets.

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.