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'Some contagion, some interdependence': More pitfalls in tests of financial contagion

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

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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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 24 (2005)
Issue (Month): 8 (December)
Pages: 1177-1199

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Handle: RePEc:eee:jimfin:v:24:y:2005:i:8:p:1177-1199
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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  1. Eichengreen, Barry & Rose, Andrew & Wyplosz, Charles, 1996. " Contagious Currency Crises: First Tests," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(4), pages 463-84, December.
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  3. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "What caused the Asian currency and financial crisis?," Japan and the World Economy, Elsevier, vol. 11(3), pages 305-373, October.
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  9. Giancarlo Corsetti & Marcello Pericoli & Massimo Sbracia, 2001. "Correlation Analysis of Financial Contagion: What One Should Know Before Running a Test," Working Papers 822, Economic Growth Center, Yale University.
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  12. Taimur Baig & Ilan Goldfajn, 2000. "The Russian Default and the Contagion to Brazil," IMF Working Papers 00/160, International Monetary Fund.
  13. 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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  16. Sebastian Edwards, 1998. "Interest Rate Volatility, Capital Controls, and Contagion," NBER Working Papers 6756, National Bureau of Economic Research, Inc.
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