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Financial contagion and tests using instrumental variables

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Author Info
Andreas Pick

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Abstract

This paper considers empirical tests for the contagion of financial crises that address the endogeneity of contagion by using instrumental variable estimation techniques. Two complications in the application to contagion are that the regression model is potentially incoherent and that it contains a parameter that is not identified under the null of no contagion. Monte Carlo experiments suggest that their influence is small in practice with the notable exception of similar tests, where both size and power are affected. An application to stock market data for the UK, USA, and Japan shows that ignoring the endogeneity of contagion leads to highly significant contagion coefficients. However, tests for contagion that takes the endogeneity into account result in mixed evidence for financial contagion.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 139.

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Date of creation: Jun 2007
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Handle: RePEc:dnb:dnbwpp:139

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Related research
Keywords: Financial crises contagion non-linear simultaneous equation models

Find related papers by JEL classification:
C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data
G3 - Financial Economics - - Corporate Finance and Governance

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