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Some Contagion, Some Interdependence: More Pitfalls in Tests of Financial Contagion

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  • Corsetti, Giancarlo
  • Pericoli, Marcello
  • Sbracia, Massimo

Abstract

This Paper develops a test of contagion in financial markets based on bivariate correlation analysis, which generalizes existing tests, and applies it to the international effects of the Hong Kong stock market crisis of October 1997. Contagion is defined as a structural break in the international transmission of financial shocks. For plausible values of the variance of country-specific shocks in Hong Kong, our test finds evidence of contagion for 5 countries out of a sample of 17. This is in sharp contrast with the findings of recent literature, according to which there is 'no contagion, only interdependence'. We show that this strong result in the literature is due to arbitrary and unrealistic restrictions on the variance of country-specific shocks.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3310.

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Date of creation: Apr 2002
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Handle: RePEc:cpr:ceprdp:3310

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Keywords: contagion; correlation analysis; factor model; financial crisis;

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  1. Mico Loretan & William B. English, 2000. "Evaluating "correlation breakdowns" during periods of market volatility," International Finance Discussion Papers 658, Board of Governors of the Federal Reserve System (U.S.).
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  12. Reinhart, Carmen & Kaminsky, Graciela, 1998. "On crises, contagion, and confusion," MPRA Paper 13709, University Library of Munich, Germany.
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  15. Marcello Pericoli & Massimo Sbracia, 2003. "A Primer on Financial Contagion," Journal of Economic Surveys, Wiley Blackwell, vol. 17(4), pages 571-608, 09.
  16. Giancarlo Corsetti & Marcello Pericoli & Massimo Sbracia, 2001. "Correlation Analysis of Financial Contagion: What One Should Know before Running a Test," Temi di discussione (Economic working papers) 408, Bank of Italy, Economic Research and International Relations Area.
  17. Michael D. Bordo & Antu P. Murshid, 2000. "Are Financial Crises Becoming Increasingly More Contagious? What is the Historical Evidence on Contagion?," NBER Working Papers 7900, National Bureau of Economic Research, Inc.
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