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Unobservable Shocks as Carriers of Contagion: A Dynamic Analysis Using Identified Structural GARCH

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Author Info
Mardi Dungey () (Univeristy of Cambridge)
George Milunovich () (Macquarie University)
Susan Thorp () (University of Technology, Sydney)

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Abstract

Markets in financial crisis may experience heightened sensitivity to news from abroad and they may also spread turbulence into foreign markets, creating contagion. We use a structural GARCH model to separate and measure these two parts of crisis transmission. Unobservable structural shocks are named and linked to source markets using variance decompositions, allowing clearer interpretation of impulse response functions. Applying this method to data from the Asian crisis, we find signifcant contagion from Hong Kong to nearby markets but little heightened sensitivity. Impulse response functions for an equally-weighted equity portfolio show the increasing dominance of Korean and Hong Kong shocks during the crisis, whereas Indonesia\'s infuence shrinks.

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Paper provided by National Centre for Econometric Research in its series NCER Working Paper Series with number 22.

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Length: 26
Date of creation: 25 Feb 2008
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Handle: RePEc:qut:auncer:2008-11

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Related research
Keywords: Contagion; Structural GARCH;

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Find related papers by JEL classification:
F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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  1. Favero, Carlo A. & Giavazzi, Francesco, 2002. "Is the international propagation of financial shocks non-linear?: Evidence from the ERM," Journal of International Economics, Elsevier, vol. 57(1), pages 231-246, June. [Downloadable!] (restricted)
  2. P. Hartmann & S. Straetmans & C. G. de Vries, 2004. "Asset Market Linkages in Crisis Periods," The Review of Economics and Statistics, MIT Press, vol. 86(1), pages 313-326, 01. [Downloadable!] (restricted)
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  3. Ilan Goldfajn & Taimur Baig, 1999. "Financial market contagion in the Asian crisis," Textos para discussão 400, Department of Economics PUC-Rio (Brazil). [Downloadable!]
  4. Nobuhiro Kiyotaki & John Moore, 2002. "Balance-Sheet Contagion," American Economic Review, American Economic Association, vol. 92(2), pages 46-50, May. [Downloadable!]
  5. Sandro Brusco & Fabio Castiglionesi, 2007. "Liquidity Coinsurance, Moral Hazard, and Financial Contagion," Journal of Finance, American Finance Association, vol. 62(5), pages 2275-2302, October. [Downloadable!] (restricted)
  6. 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!]
  7. M. Hashem Pesaran & Andreas Pick, 2004. "Econometric Issues in the Analysis of Contagion," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  8. Roberto Rigobon, 1999. "On the Measurement of the International Propagation of Shocks," NBER Working Papers 7354, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Kristin Forbes & Roberto Rigobon, 1999. "No Contagion, Only Interdependence: Measuring Stock Market Co-movements," NBER Working Papers 7267, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Cerra, Valerie & Saxena, Sweta Chaman, 2002. "Contagion, Monsoons, and Domestic Turmoil in Indonesia's Currency Crisis," Review of International Economics, Blackwell Publishing, vol. 10(1), pages 36-44, February. [Downloadable!] (restricted)
  11. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," Review of Economic Studies, Blackwell Publishing, vol. 75(4), pages 1215-1256, October. [Downloadable!] (restricted)
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  12. Taimur Baig & Ilan Goldfajn, 1999. "Financial Market Contagion in the Asian Crisis," IMF Staff Papers, Palgrave Macmillan Journals, vol. 46(2), pages 3. [Downloadable!] (restricted)
  13. Billio, Monica & Pelizzon, Loriana, 2003. "Contagion and interdependence in stock markets: Have they been misdiagnosed?," Journal of Economics and Business, Elsevier, vol. 55(5-6), pages 405-426. [Downloadable!] (restricted)
  14. Roberto Rigobon & Brian Sack, 2002. "The impact of monetary policy on asset prices," Finance and Economics Discussion Series 2002-4, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  15. Lin, Wen-Ling, 1997. "Impulse Response Function for Conditional Volatility in GARCH Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 15(1), pages 15-25, January.
  16. Corsetti, Giancarlo & Pericoli, Marcello & Sbracia, Massimo, 2005. "'Some contagion, some interdependence': More pitfalls in tests of financial contagion," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1177-1199, December. [Downloadable!] (restricted)
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  17. Dornbusch, Rudiger & Park, Yung Chul & Claessens, Stijn, 2000. "Contagion: Understanding How It Spreads," World Bank Research Observer, Oxford University Press, vol. 15(2), pages 177-97, August.
  18. Rothenberg, Thomas J, 1971. "Identification in Parametric Models," Econometrica, Econometric Society, vol. 39(3), pages 577-91, May. [Downloadable!] (restricted)
  19. Shaun Bond & Mardi Dungey & Renée Fry, 2006. "A Web Of Shocks: Crises Across Asian Real Estate Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 32(3), pages 253-274, May. [Downloadable!] (restricted)
  20. 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. [Downloadable!] (restricted)
  21. Vance L. Martin & Mardi Dungey, 2007. "Unravelling financial market linkages during crises," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 89-119. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Thomas J. Flavin & Ekaterini Panopoulou & Deren Unalmis, 2008. "On the stability of domestic financial market linkages in the presence of time-varying volatility," Economics, Finance and Accounting Department Working Paper Series n1981108.pdf, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth. [Downloadable!]
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