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Strong Contagion with Weak Spillovers

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  • Martin Ellison

    (University of Warwick)

  • Liam Graham

    (University College London)

  • Jouko Vilmunen

    (Bank of Finland)

Abstract

In this paper, we develop an explanation for why events in one market may trigger similar events in other markets, even though at first sight the markets appear to be only weakly related. We allow for escape dynamics in each market, and show that an escape in one market is contagious because it more than doubles the probability of a similar escape in another market. We claim that contagion is strong since escapes become highly synchronised across markets. Spillovers are weak because the instantaneous spillover of events from one market to another is small. To illustrate our result, we demonstrate how a currency crisis may be contagious with only weak links between countries. Other examples where weak spillovers would create strong contagion are various models of monetary policy, imperfect competition and endogenous growth. (Copyright: Elsevier)

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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 9 (2006)
Issue (Month): 2 (April)
Pages: 263-283

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Handle: RePEc:red:issued:v:9:y:2006:i:2:p:263-283

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Keywords: Contagion; Escape dynamics; Learning; Spillovers;

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References

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  1. Robert J. Tetlow & Peter von zur Muehlen, 2002. "Avoiding Nash inflation: Bayesian and robust responses to model uncertainty," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2002-9, Board of Governors of the Federal Reserve System (U.S.).
  2. Noah Williams, 2003. "Small Noise Asymptotics for a Stochastic Growth Model," Computing in Economics and Finance 2003, Society for Computational Economics 262, Society for Computational Economics.
  3. Cho, In-Koo & Sargent, Thomas J., 2000. "Escaping Nash inflation," Working Paper Series, European Central Bank 0023, European Central Bank.
  4. Thomas Sargent & Noah Williams & Tao Zha, 2009. "The Conquest of South American Inflation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 117(2), pages 211-256, 04.
  5. Bullard, James & Cho, In-Koo, 2003. "Escapist policy rules," CFS Working Paper Series, Center for Financial Studies (CFS) 2003/38, Center for Financial Studies (CFS).
  6. Bruce McGough, 2003. "Shocking Escapes," Computing in Economics and Finance 2003, Society for Computational Economics 294, Society for Computational Economics.
  7. Giorgio Primiceri, 2005. "Why Inflation Rose and Fell: Policymakers' Beliefs and US Postwar Stabilization Policy," NBER Working Papers 11147, National Bureau of Economic Research, Inc.
  8. Kenneth Kasa, 2004. "Learning, Large Deviations, And Recurrent Currency Crises," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(1), pages 141-173, 02.
  9. William Poole, 2002. "Flation," Speech, Federal Reserve Bank of St. Louis 49, Federal Reserve Bank of St. Louis.
  10. Masson, Paul, 1999. "Contagion:: macroeconomic models with multiple equilibria," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(4), pages 587-602, August.
  11. Philippe AGHION & Philippe BACCHETTA & Abhijit BANERJEE, 1999. "A Simple Model of Monetary Policy and Currency Crises," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP), Université de Lausanne, Faculté des HEC, DEEP 9914, Université de Lausanne, Faculté des HEC, DEEP.
  12. In-Koo Cho & Kenneth Kasa, 2003. "Learning Dynamics and Endogenous Currency Crises," Computing in Economics and Finance 2003, Society for Computational Economics 132, Society for Computational Economics.
  13. Gerali, Andrea & Lippi, Francesco, 2001. "On the 'Conquest' of Inflation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3101, C.E.P.R. Discussion Papers.
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Cited by:
  1. Thomas Sargent & Noah Williams & Tao Zha, 2009. "The Conquest of South American Inflation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 117(2), pages 211-256, 04.

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