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Strong Contagion with Weak Spillovers

  • Martin Ellison

    (University of Warwick)

  • Liam Graham

    (University College London)

  • Jouko Vilmunen

    (Bank of Finland)

In this paper, we develop an explanation for why events in one market may trigger similar events in other markets, even though at first sight the markets appear to be only weakly related. We allow for escape dynamics in each market, and show that an escape in one market is contagious because it more than doubles the probability of a similar escape in another market. We claim that contagion is strong since escapes become highly synchronised across markets. Spillovers are weak because the instantaneous spillover of events from one market to another is small. To illustrate our result, we demonstrate how a currency crisis may be contagious with only weak links between countries. Other examples where weak spillovers would create strong contagion are various models of monetary policy, imperfect competition and endogenous growth. (Copyright: Elsevier)

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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 9 (2006)
Issue (Month): 2 (April)
Pages: 263-283

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Handle: RePEc:red:issued:v:9:y:2006:i:2:p:263-283
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  1. Bruce McGough, 2006. "Shocking Escapes," Economic Journal, Royal Economic Society, vol. 116(511), pages 507-528, 04.
  2. Robert Tetlow & Peter von zur Muehlen, 2004. "Avoiding Nash Inflation: Bayesian and Robus Responses to Model Uncertainty," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(4), pages 869-899, October.
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  8. Kenneth Kasa, 2000. "Learning, large deviations, and recurrent currency crises," Working Paper Series 2000-10, Federal Reserve Bank of San Francisco.
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  10. William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
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  12. Masson, Paul, 1999. "Contagion:: macroeconomic models with multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 587-602, August.
  13. In-Koo Cho & Kenneth Kasa, 2003. "Learning Dynamics and Endogenous Currency Crises," Computing in Economics and Finance 2003 132, Society for Computational Economics.
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