Strong Contagion with Weak Spillovers

36 Pages Posted: 15 Feb 2005

See all articles by Martin Ellison

Martin Ellison

University of Oxford

Liam Graham

University College London - Department of Economics

Jouko Vilmunen

Bank of Finland, Research Unit

Date Written: November 2004

Abstract

In this Paper, we develop a model which explains why events in one market may trigger similar events in other markets, even though at first sight the markets appear to be only weakly related. We allow for multiple equilibria and learning dynamics in each market, and show that a jump between equilibria in one market is contagious because it more than doubles the probability of a similar jump in another market. We claim that contagion is strong since equilibrium jumps become highly synchronized across markets. Spillovers are weak because the instantaneous spillover of events from one market to another is small. To illustrate our result, we demonstrate how a currency crisis may be contagious with only weak links between countries. Other examples where weak spillovers would create strong contagion are various models of monetary policy, imperfect competition and endogenous growth.

Keywords: Contagion, escape dynamics, learning, spillovers

JEL Classification: E50, F40

Suggested Citation

Ellison, Martin and Graham, Liam and Vilmunen, Jouko, Strong Contagion with Weak Spillovers (November 2004). CEPR Discussion Paper No. 4762, Available at SSRN: https://ssrn.com/abstract=664582

Martin Ellison (Contact Author)

University of Oxford ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

Liam Graham

University College London - Department of Economics ( email )

Gower Street
London, WC1E 6BT
United Kingdom

Jouko Vilmunen

Bank of Finland, Research Unit ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

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