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A Markov regime switching model of crises and contagion: The case of the Iberian countries in the EMS

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  • Lopes, José Mário
  • Nunes, Luis C.

Abstract

We develop a general econometric model of currency crises and contagion that integrates a number of important features appearing in many different models recently proposed in the literature. In particular, we consider a Markov regime switching vector autoregression conditional heteroskedastic model with time-varying transition probabilities allowing for shifting correlations. This model is used to study the case of the Portuguese escudo and the Spanish peseta during the EMS crisis. The results show that, in a crisis situation, the interest rate differential has different effects on the transition probability from the crisis state to the non-crisis state: a perverse effect for Portugal, and a positive effect for Spain. We also find strong evidence of contagion, mostly from the Spanish peseta to the Portuguese escudo, and to some extent from the Portuguese escudo to the Spanish peseta.

Suggested Citation

  • Lopes, José Mário & Nunes, Luis C., 2012. "A Markov regime switching model of crises and contagion: The case of the Iberian countries in the EMS," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 1141-1153.
  • Handle: RePEc:eee:jmacro:v:34:y:2012:i:4:p:1141-1153
    DOI: 10.1016/j.jmacro.2012.08.007
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    Cited by:

    1. Qiang Ji & Bing-Yue Liu & Juncal Cunado & Rangan Gupta, 2017. "Risk Spillover between the US and the Remaining G7 Stock Markets Using Time-Varying Copulas with Markov Switching: Evidence from Over a Century of Data," Working Papers 201759, University of Pretoria, Department of Economics.

    More about this item

    Keywords

    Currency crisis; Contagion; Markov switching; Volatility;

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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