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Looking for Contagion: Evidence from the ERM

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  • Carlo A. Favero
  • Francesco Giavazzi

Abstract

This paper applies a full-information technique to test for the presence of contagion across the money markets of ERM member countries. We show that whenever it is possible to estimate a model for interdependence, a test for contagion based on a full information technique is more powerful. We test for the presence of contagion after having identified episodes of country-specific shocks, whose effects on other European markets are significantly different from those predictable from the estimated channels of interdependence. Using data on three-months interest rate spreads on German rates for seven countries over the period 1988-1992, we are unable to reject the null of contagion. Our evidence suggest that contagion within the ERM was a general phenomenon, not limited to a subset of weaker countries, the exception in the sample being France. Our results are mute as to the question of what lies behind these episodes of contagion; they show, however, that it is not always true that one only detects contagion when one applies poor statistical techniques.

Suggested Citation

  • Carlo A. Favero & Francesco Giavazzi, 2000. "Looking for Contagion: Evidence from the ERM," NBER Working Papers 7797, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:7797
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    File URL: http://www.nber.org/papers/w7797.pdf
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    References listed on IDEAS

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    1. Taimur Baig & Ilan Goldfajn, 1999. "Financial Market Contagion in the Asian Crisis," IMF Staff Papers, Palgrave Macmillan, vol. 46(2), pages 1-3.
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    6. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-144, January.
    7. Roberto Rigobon, 1999. "On the Measurement of the International Propagation of Shocks," NBER Working Papers 7354, National Bureau of Economic Research, Inc.
    8. Kristin J. Forbes & Roberto Rigobon, 2002. "No Contagion, Only Interdependence: Measuring Stock Market Comovements," Journal of Finance, American Finance Association, vol. 57(5), pages 2223-2261, October.
    9. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
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    Citations

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    Cited by:

    1. 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.
    2. Essahbi Essaadi & Jamel Jouini & Wajih Khallouli, 2009. "The Asian Crisis Contagion: A Dynamic Correlation Approach Analysis," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(2), pages 241-260, June.
    3. Lizarazo, Sandra Valentina, 2013. "Default risk and risk averse international investors," Journal of International Economics, Elsevier, vol. 89(2), pages 317-330.
    4. Sander, Harald & Kleimeier, Stefanie, 2003. "Contagion and causality: an empirical investigation of four Asian crisis episodes," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 13(2), pages 171-186, April.
    5. Margarida Abreu, 2003. "Contagion Phenomena in Financial Crises: Evidence from the Portuguese and Spanish Exchange Rate Crises in the Early Nineties," Working Papers Department of Economics 2003/05, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    6. Radovan Vadovic, 2009. "Early, Late, and Multiple Bidding in Internet Auctions," Working Papers 0904, Centro de Investigacion Economica, ITAM.
    7. Coudert, Virginie & Couharde, Cécile & Mignon, Valérie, 2011. "Exchange rate volatility across financial crises," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3010-3018, November.
    8. Sergio L. Schmukler, 2004. "Financial globalization: gain and pain for developing countries," Economic Review, Federal Reserve Bank of Atlanta, issue Q 2, pages 39-66.
    9. Renee Fry & Vance Martin & Brenda Gonzalez-Hermosillo & Mardi Dungey, 2002. "International Contagion Effects from the Russian Crisis and the LTCM Near-Collapse," IMF Working Papers 02/74, International Monetary Fund.
    10. Fazio, Giorgio, 2007. "Extreme interdependence and extreme contagion between emerging markets," Journal of International Money and Finance, Elsevier, vol. 26(8), pages 1261-1291, December.
    11. Toni Gravelle & Maral Kichian & James Morley, 2003. "Shift Contagion in Asset Markets," Staff Working Papers 03-5, Bank of Canada.
    12. Wajih Khallouli, 2008. "Shift-Contagion in Middle East and North Africa Stock Markets," Working Papers 420, Economic Research Forum, revised 06 Jan 2008.

    More about this item

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • F3 - International Economics - - International Finance

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