Contagion Detection with Switching Regime Models: A Short and Long Run Analysis

26 Pages Posted: 5 Mar 2005

See all articles by Monica Billio

Monica Billio

Ca Foscari University of Venice - Dipartimento di Economia

Marco Lo Duca

European Central Bank (ECB)

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration; Leibniz Institute for Financial Research SAFE; Ca Foscari University of Venice

Date Written: February 28, 2005

Abstract

The paper evaluates the potentialities of Markov switching models (MS) in contagion analysis. We intend contagion as a break that produces non-linearities in the linkages among financial markets. The MS approach allows the detection of contagion in a more general framework since, differently from the previous literature, (i) the crisis period are endogenously defined by the MS model rather than arbitrarily and are specific for each country, (ii) we investigate the flight to quality effect, i.e. when the non-linear relationship among markets who implies a significant reduction of the link among markets during a crisis period, and (iii) we distinguish between short and long run breaks using Markov switching ECM models.

We analyse the period of the Hong Kong stock market crash in 1997. The results show that (i) the relationship between developed markets strengthens, as that between the Hong Kong market and the US and European markets (i.e. contagion) and (ii) the factor loading of the error correction term shows a flight to quality effect suggesting that investors during crisis potentially ignore economic fundamentals.

Keywords: Contagion, stock market crises, international financial markets, financial integration, Markov switching models, long run analysis

JEL Classification: G18, C33

Suggested Citation

Billio, Monica and Lo Duca, Marco and Pelizzon, Loriana, Contagion Detection with Switching Regime Models: A Short and Long Run Analysis (February 28, 2005). Available at SSRN: https://ssrn.com/abstract=676956 or http://dx.doi.org/10.2139/ssrn.676956

Monica Billio (Contact Author)

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

HOME PAGE: http://www.unive.it/persone/billio

Marco Lo Duca

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Leibniz Institute for Financial Research SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

HOME PAGE: http://www.safe-frankfurt.de

Ca Foscari University of Venice ( email )

Dorsoduro 3246
Venice, Veneto 30123
Italy

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