Tail Risks and Domino Patterns in Emerging Currency Markets
Posted: 8 Dec 2017 Last revised: 19 Oct 2018
Date Written: December 7, 2017
We identify new structural channels for the transmission of shocks in emerging currencies, by developing a model in which shock propagations evolve from domestic emerging stock markets, liquidity, credit risk and growth channels. We employ symmetric and asymmetric copulas to quantify joint downside risks and document that these asset classes tend to experience concurrent extreme shocks. The time-varying shock spillover intensities cause a significant increase in cross-asset linkages during periods of high volatility which is over and above any expected economic fundamentals, providing strong evidence of asymmetric investor induced contagion. The critical role of the credit crisis is amplified, as the beginning of an important reassessment of emerging currencies which lead to changes in the dependence structure, a revaluation and recalibration of their risk characteristics. By modelling tail risks we detect structural breaks and find patterns consistent with the domino effect.
Keywords: Asymmetric Foreign Exchange Volatility, Emerging Markets, Tail Risk, Contagion Channels, Domino Effect, Copula Functions
JEL Classification: C5, F31, F37, G01, G17
Suggested Citation: Suggested Citation