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Econometric Issues in the Analysis of Contagion

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Author Info
M. Hashem Pesaran ()
Andreas Pick ()

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Abstract

This paper presents a canonical, econometric model of contagion and investigates the conditions under which contagion can be distinguished from inter-dependence. In a two-country (market) setup it is shown that for a range of fundamentals the solution is not unique, and for sufficiently large values of the contagion coefficients it has interesting bifurcation properties with bimodal density functions. The extension of the model to herding behaviour is also briefly discussed. To identify contagion effects in the presence of inter-dependencies the equations for the individual markets or countries must contain country (market) specific forcing variables. This sheds doubt on the general validity of the correlation-based tests of contagions recently proposed in the literature which do not involve any country (market) specific fundamentals. Finally, we show that ignoring inter-dependence can introduce an upward bias in the estimate of the contagion coefficient, and using Monte Carlo experiments we further show that this bias could be substantial.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 1176.

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Date of creation: 2004
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Handle: RePEc:ces:ceswps:_1176

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Related research
Keywords: contagion; inter-dependence; identification; financial crises;

Other versions of this item:

Find related papers by JEL classification:
C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - General
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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References listed on IDEAS
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  1. Mardi Dungey & Renee Fry & Vance Martin & Brenda González-Hermosillo, 2004. "Empirical Modeling of Contagion: A Review of Methodologies," IMF Working Papers 04/78, International Monetary Fund. [Downloadable!]
    Other versions:
  2. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania. [Downloadable!]
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This page was last updated on 2009-11-3.

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