The contagion effect: evidences from former Soviet Economies in Eastern Europe

This paper analyzes whether or not the contagion effect exists among the seven former-Soviet economies in Eastern Europe: Belarus, Estonia, Latvia, Lithuania, Moldova, Russia and Ukraine throughout the period from November 1996 to December 2009. The evolution of the EU memberships of Estonia, Latvia and Lithuania has been assessed over the membership period (2004:05-2009:12) in comparison to the non-membership period (1995:11-2004:04). Additionally, the economies and the sample period employed in this research give an opportunity to test for two hypotheses on the contagion effect: First, the “flight to quality” hypothesis suggested by Favero and Giavazzi (2002) and second, the “political contagion” hypothesis offered by Drazen (1999). The contagion effect hypotheses for each economy have been tested using the “Threshold Test” proposed by Pesaran and Pick (2007). The econometric method employed in this paper examines only the contagion effect, not the interdependence although the seven economies or groups in the analysis can have interdependence relations. Empirical analysis has highlighted that: (i) the contagion effect exists in the region; (ii) the structure of the contagion mechanism in the region is not stable during the estimation period; (iii) there is an evidence for the validity of “flight to quality” hypothesis; (iv) there is no evidence for the validity of the “political contagion” hypothesis. These results are consistent with the different regional patterns of the former Soviet countries.