Modeling Financial Contagion Using Mutually Exciting Jump Processes

50 Pages Posted: 29 Mar 2010 Last revised: 9 Apr 2010

See all articles by Yacine Ait-Sahalia

Yacine Ait-Sahalia

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Julio Cacho-Diaz

Princeton University - Department of Economics

Roger J. A. Laeven

University of Amsterdam - Department of Quantitative Economics (KE)

Date Written: March 2010

Abstract

Adverse shocks to stock markets propagate across the world, with a jump in one region of the world seemingly causing an increase in the likelihood of a different jump in another region of the world. To capture this effect mathematically, we introduce a model for asset return dynamics with a drift component, a volatility component and mutually exciting jumps known as Hawkes processes. In the model, a jump in one region of the world or one segment of the market increases the intensity of jumps occurring both in the same region (self-excitation) as well as in other regions (cross-excitation). The model generates the type of jump clustering that is observed empirically. Jump intensities then mean-revert until the next jump. We develop and implement an estimation procedure for this model. Our estimates provide evidence for self-excitation both in the US market as well as in other world markets. Furthermore, we find that US jumps tend to get reflected quickly in most other markets, while statistical evidence for the reverse transmission is much less pronounced. Implications of the model for measuring market stress, risk management and optimal portfolio choise are also investigated.

Suggested Citation

Ait-Sahalia, Yacine and Cacho-Diaz, Julio and Laeven, Roger Jean Auguste, Modeling Financial Contagion Using Mutually Exciting Jump Processes (March 2010). NBER Working Paper No. w15850, Available at SSRN: https://ssrn.com/abstract=1578687

Yacine Ait-Sahalia (Contact Author)

Princeton University - Department of Economics ( email )

Fisher Hall
Princeton, NJ 08544
United States
609-258-4015 (Phone)
609-258-5398 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Julio Cacho-Diaz

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

Roger Jean Auguste Laeven

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Valckenierstraat 65-67
Amsterdam, 1018 XE
Netherlands
+31 20 525 4252 (Phone)

HOME PAGE: http://www.rogerlaeven.com

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
84
Abstract Views
969
rank
325,731
PlumX Metrics