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Testing for Contagion: a Time-Scale Decomposition

Author

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  • Andrea Cipollini
  • Iolanda Lo Cascio

Abstract

The aim of the paper is to test for ¯nancial contagion by estimating a simultaneous equation model subject to structural breaks. For this purpose, we use the Maximum Overlapping Discrete Wavelet Transform, MODWT, to decompose the covariance matrix of four asset returns on a scale by scale basis. This decomposition will enable us to identify the structural form model and to test for spillover e®ects between country speci¯c shocks during a crisis period. We distinguish between the case of the structural form model with a single dummy and the one with multiple dummies capturing shifts in the co-movement of asset returns occurring during periods of ¯nancial turmoil. The empirical results for four East Asian emerging stock markets show that, once we account for interdependence through an (unobservable) common factor, there is hardly any evidence of contagion during the 1997-1998 financial turbulence.

Suggested Citation

  • Andrea Cipollini & Iolanda Lo Cascio, 2010. "Testing for Contagion: a Time-Scale Decomposition," Center for Economic Research (RECent) 047, University of Modena and Reggio E., Dept. of Economics "Marco Biagi".
    • Handle: RePEc:mod:recent:047
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    References listed on IDEAS

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    1. Pesaran, M. Hashem & Pick, Andreas, 2007. "Econometric issues in the analysis of contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1245-1277, April.
    2. Dungey, Mardi & Milunovich, George & Thorp, Susan, 2010. "Unobservable shocks as carriers of contagion," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 1008-1021, May.
    3. Caporale, Guglielmo Maria & Cipollini, Andrea & Spagnolo, Nicola, 2005. "Testing for contagion: a conditional correlation analysis," Journal of Empirical Finance, Elsevier, vol. 12(3), pages 476-489, June.
    4. Kristin J. Forbes & Roberto Rigobon, 2002. "No Contagion, Only Interdependence: Measuring Stock Market Comovements," Journal of Finance, American Finance Association, vol. 57(5), pages 2223-2261, October.
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    More about this item

    Keywords

    wavelets; simultaneous equations model; financial contagion;
    All these keywords.

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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