Testing for Asymmetric Financial Contagion: New Evidence from the Asian Crisis

Abstract

This paper investigates financial contagion as an asymmetric propagation mechanism across both equity and foreign exchange markets. In order to provide a robust analysis of the contagion dynamics, we apply an asymmetric generalized dynamic conditional correlation (AG-DCC) model. This specification allows examining the presence of asymmetric responses in correlations to negative returns, focusing on four countries affected by a specific emerging-market crisis (Asian crisis in 1997-1998). We find that conditional correlations among stock (currency) markets increase significantly during the crisis period, supporting the presence of asymmetric responses to negative shocks and the contagion phenomenon. The results also support the regional nature of this crisis, which is also spread with a higher magnitude among equity rather than currency markets. This evidence has important implications for portfolio diversification strategies and the effectiveness of policy responses to prevent the spread of the crisis among countries.

Keywords: Contagion, Stock and currency markets, Asymmetric dynamic conditional correlation, Asian financial crisis

JEL Classification: F30, G15, C30