Some Contagion, Some Interdependence: More Pitfalls in Tests of Financial Contagion

23 Pages Posted: 5 Sep 2008  

Giancarlo Corsetti

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS); University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Marcello Pericoli

Bank of Italy

Massimo Sbracia

Bank of Italy

Multiple version iconThere are 2 versions of this paper

Date Written: September 4, 2005

Abstract

This paper builds on a standard factor model of stock market returns to reconsider recent empirical literature on contagion in financial markets based on bivariate correlation analysis. According to this literature, contagion is defined as a structural break in the linear transmission mechanism of financial shocks. Using our framework, we show that the result of 'no contagion, only interdependence' stressed by recent contributions is due to arbitrary and unrealistic restrictions on the variance of country-specific shocks. We focus on the international effects of the Hong Kong stock market crisis of October 1997 as a case study. For plausible values of the variance of country-specific shocks in Hong Kong, current tests cannot reject the null of interdependence for 16 countries out of a sample of 17. Our analysis strongly questions such conclusion, finding evidence of 'contagion' for at least five countries.

Keywords: Contagion; Financial crisis; Factor model; Correlation analysis

JEL Classification: F30, C10, G10, G15

Suggested Citation

Corsetti, Giancarlo and Pericoli, Marcello and Sbracia, Massimo, Some Contagion, Some Interdependence: More Pitfalls in Tests of Financial Contagion (September 4, 2005). Journal of International Money and Finance, Vol. 24, 2005. Available at SSRN: https://ssrn.com/abstract=1263402

Giancarlo Corsetti

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

Villa La Fonte, via delle Fontanelle 18
50016 San Domenico di Fiesole
Florence, Florence 50014
Italy

University of Rome III - Department of Economics ( email )

via Ostiense, 139
Rome, 00154
Italy
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Marcello Pericoli (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

HOME PAGE: http://www.bancaditalia.it

Massimo Sbracia

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy
+39 06 4792 3860 (Phone)
+39 06 4792 4118 (Fax)

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