Dynamic Correlation Analysis of Financial Contagion: Evidence from Asian Countries

Abstract

This paper reexamines Asian stock market contagion by applying a dynamic multivariate GARCH model to daily stock-return data in nine Asian countries and the United States during the period from 1996 to 2003. The empirical results find supportive evidence of a contagion effect. By analyzing the correlation-coefficient series, this paper identifies two phases of the Asian crisis. The first phase shows an increase in correlation (contagion) and the second phase shows continued high correlation (herding). Statistical analysis of the correlation coefficients shows shifts in the level as well as in the variance of the correlation coefficients during the crisis period, casting some doubt on the benefit of international portfolio diversification. This study finds that international rating agents play significant role in shaping the structure of dynamic correlations in the Asian markets.

Keywords: Financial contagion, Asian crises, Herding, Dynamic correlation coefficient, Sovereign rating

JEL Classification: F30, G15