Are stock market crises contagious? The role of crisis definitions

Financial contagion studies generally examine whether co-movement between markets increases during a crisis. We use a flexible co-movement measure to examine how conclusions of such analyses depend on the sample chosen as the ‘crisis’. To this end, we analyse stock market co-movement during the 1997 Asian crisis and the 2007 global financial crisis for all possible source countries and for all possible time periods or extreme return quantiles. This way we account for the main crisis dating approaches adopted in the literature. Our results suggest there is no clear relationship between excess co-movement and commonly used crisis samples.     

Cointegration and causality in the Asian and emerging foreign exchange markets: Evidence from the 1990s financial crises

This article examines the cointegration level, changes in the existence and directions of causality of the foreign exchange (FX) rates in the Asian and emerging markets during the 1990s financial crises. Engle and Granger's simple bivariate and Johansen's multivariate cointegrations are applied to the FX rates for the 1994 Mexican, 1997 Asian, 1998 Russian, and 1999 Brazilian crises. In addition, the article conducts the Granger causality test and impulse response analysis to examine the causality pattern in all the FX rates. The analysis shows most of the pre-Mexican causality disappears and significant numbers of new causality emerge in the 1994 Mexican crisis while the 1997 Asian crisis generates significant spillover effects into the later part of the 1998 Russian and 1999 Brazilian crises.     

Crisis Transmission: Evidence from the Debt, Tequila, and Asian Flu Crises

This article analyzes how external crises spread across countries.The authors analyze the behavior of four alternative crisisindicators in a sample of 20 countries during three well-knowncrises: the 1982 debt crisis, the 1994 Mexican crisis, and the1997 Asian crisis. The objective is twofold: to revisit thetransmission channels of crises, and to analyze whether capitalcontrols, exchange rate flexibility, and debt maturity structureaffect the extent of contagion. The results indicate that thereis a strong neighborhood effect. Trade links and similarityin precrisis growth also explain (to a lesser extent) whichcountries suffer more contagion. Both debt composition and exchangerate flexibility to some extent limit contagion, whereas capitalcontrols do not appear to curb it.     

No Contagion, Only Interdependence: Measuring Stock Market Comovements

Heteroskedasticity biases tests for contagion based on correlation coefficients. When contagion is defined as a significant increase in market comovement after a shock to one country, previous work suggests contagion occurred during recent crises. This paper shows that correlation coefficients are conditional on market volatility. Under certain assumptions, it is possible to adjust for this bias. Using this adjustment, there was virtually no increase in unconditional correlation coefficients (i.e., no contagion) during the 1997 Asian crisis, 1994 Mexican devaluation, and 1987 U.S. market crash. There is a high level of market comovement in all periods, however, which we call interdependence.     

Testing financial contagion on heteroskedastic asset returns in time-varying conditional correlation

We suggest that there is a significant relationship between cross-market comovement and time varying volatility. The time-varying component of cross-market dependence is attributed to the intertemporal risk-return adjustment by rational, risk-averse investors who systematically revise their expectation in response to changing volatility. To reflect the time-varying component of cross-market dependence, we propose a time-varying correlation test for contagion. Our results show that out of the countries reporting contagion evidence under the constant correlation test, none of the countries exhibits contagion evidence from the 1997 Asian crisis. We conclude that a high level of cross-market correlation during a crisis reported as contagion evidence under the standard constant correlation test is mostly due to the high level of cross-market co-movement resulting from the intertemporal risk-return adjustment.     

Financial flexibility,corporate investment and performance: evidence from financial crises

This study examines the impact of financial flexibility on the investment and performance of East Asian firms over the period 1994–2009. We employ a sample of 1,068 firms and place particular emphasis on the periods of the Asian crisis (1997–1998) and the recent credit crisis (2007–2009). The results show that firms can attain financial flexibility, primarily through conservative leverage policies and less commonly by holding large cash balances. Financial flexibility appears to be an important determinant of investment and performance, mainly during the Asian 1997–1998 crisis. In particular, firms that are financially flexible prior to this crisis (1) have a greater ability to take investment opportunities, (2) rely much less on the availability of internal funds to invest, and (3) perform better than less flexible firms during the crisis. Our analysis covering the credit crisis period of 2007–2009 suggests that some of the advantages of flexible firms towards investing persist but are significantly less pronounced over that period. We also find that the value of financial flexibility is region/country specific, which may be explained by the fact that different regions/countries often adopt different macroeconomic policies and operate in diverse economic/legal environments.     

Internal Market Efficiency,Market Co-movement,and Cross-Market Efficiency: The Case of Hong Kong and Shanghai Stock Markets

We examine the effects of the 2008 financial crisis on the cross-market efficiency of the Hong Kong and Shanghai stock markets. Our results show a sharp decline in the cross-market efficiency during the financial crisis. We investigate whether this is due to lower internal market efficiency or higher market co-movement. The results show no evidence that the internal market efficiency dropped in Hong Kong or Shanghai during the crisis. In contrast, we document a strong increase in the market co-movement during the crisis. These results suggest that the decline in cross-market efficiency during the financial crisis is due to increased market co-movement and not a decline in internal market efficiency.     

Dependence patterns among Asian banking sector stocks: A copula approach

Asian banks have recorded 22 banking crisis between 1945 and 2008 and its total share of years in a banking crisis since 1945 is 12.4%, the highest compared to all regions. Interestingly, most of the financial institutions in the region remained largely unscathed during the recent global financial crisis, mainly due to their strong liquidity and capital buffers. Yet, given the episodes of past crisis, the rapid increase in regional corporations and cross-border flows in the region, as well as the paramount importance of the banking sector in the Asian region, it is interesting to study how the banking sectors in the various economies co-move with each other. Against this backdrop, we examine the dependence structure between banking sectors in the region using copula functions. Several findings are documented. First, average dependence generally remain at moderate levels, though dependence between the banking sectors of the developed Asian markets are relatively higher than the emerging markets. Second, we find evidence of asymmetric dependence, suggesting that banking sector returns co-movement varies in bearish and bullish markets. Third, our results show a mild increase in the bivariate dynamic correlations during crisis periods, indicating very limited risk of contagion. Our results provide significant implications for portfolio managers and policymakers.     

Measuring financial contagion: A Copula approach

This paper models dependence with switching-parameter copulas to study financial contagion. Using daily returns from five East Asian stock indices during the Asian crisis, and from four Latin American stock indices during the Mexican crisis, it finds evidence of changing dependence during periods of turmoil. Increased tail dependence and asymmetry characterize the Asian countries, while symmetry and tail independence describe the Latin American case. Structural breaks in tail dependence are a dimension of the contagion phenomenon. Therefore, the rejection of the correlation breakdown hypothesis should not be considered, without further investigation, as evidence of a stable dependence structure.     

Are there profit (returns) in Shariah-compliant exchange traded funds? The multiscale propensity

This paper is the first attempt to investigate the multiscale tendency of the co-movement and cross-correlation of nine Islamic Exchange Traded Fund (ETF) returns across the global developed and emerging markets using both wavelet coherence and wavelet MODWT methods. The wavelet coherence results tend to indicate consistent co-movement between most of the ETF returns especially in the long run. The study also uncovers evidence of wide variation of co-movement across the time-scales during the global financial crisis and the Euro debt crisis. Strong co-movement can be observed during the global financial crisis, both for the medium term investors and long term investors. The paper studies the relationship between different ETF returns using wavelet multi-resolution analysis. The cross-correlation analysis also shows certain significant and positive correlations between the ETF returns, especially during the period of global financial crisis. The findings from these two recent dynamic time-scale decomposition methodologies have important policy implications for both risk management and investors’ investment policy.     

Using local Gaussian correlation in a nonlinear re-examination of financial contagion

This paper examines financial contagion, that is, whether the cross-market linkages in financial markets increase after a shock to a country. We use a new measure of local dependence (introduced by Tjøstheim and Hufthammer (2013)) to study the contagion effect. The central idea of the new approach is to approximate an arbitrary bivariate return distribution by a family of Gaussian bivariate distributions. At each point of the return distribution there is a Gaussian distribution that gives a good approximation at that point. The correlation of the approximating Gaussian distribution is taken as the local correlation in that neighbourhood. By examining the local Gaussian correlation before the shock (in a stable period) and after the shock (in the crisis period), we are able to test whether contagion has occurred by a bootstrap testing procedure. The use of local Gaussian correlation is compared to other methods of studying contagion. Further, the bootstrap test is examined in a Monte Carlo study, and shows good level and power properties. We illustrate our approach by re-examining the Mexican crisis of 1994, the Asian crisis of 1997–1998 and the financial crisis of 2007–2009. We find evidence of contagion based on our new procedure and are able to describe the nonlinear dependence structure of these crises.     

Exchange rate exposure in the Asian emerging markets

This paper investigates the impact of foreign exchange rate change on stock returns in the Asian emerging markets. The asymmetric exchange exposure framework and real exchange rates are used in this paper to capture the different exposures between currency appreciation and depreciation and the high inflation effect in the emerging markets. My empirical results show that there did exist extensive exchange rate exposure in the Asian emerging markets from 1997 to 2010. Moreover, foreign exchange exposure became more significant or greater during the 1997 Asian crisis and the 2008 global crisis periods, despite the frequent central banks’ interventions during these periods. The greater exchange exposure during the crisis periods can be attributable to net exporters or firms with dollar assets, implying that firms can reduce exchange exposures by decreasing their export ratio or dollar assets holding during times of crisis.     

Market efficiency, the Mexican peso crisis, and the US bank stock returns: An application of the event parameter method

This paper examines the impact of the 1994 Mexican peso crisis on US bank returns using an event parameter approach. The event parameter approach explicitly predicts the stochastic return generating process on the occurrence or nonoccurrence of specific events. The event parameter method assumes that only the intercept term may vary between the estimation and analysis periods. Specifically, this study will examine two pairs of hypotheses, new information vs. information leakage and rational pricing vs. investor contagion, in the context of the 1994 Mexican peso and banking crisis. The empirical results support the new information hypothesis, which states that US stock prices reacted quickly to events related to the Mexican peso crisis. This research has also found evidence for bank contagion, although these did not spill over to other banks. The US government and international agencies acted promptly to contain the effect of the Mexican peso and banking crisis spreading to the US and to other Latin American countries.     

Diversification,rationality and the Asian economic crisis

We examine the reaction of world equity markets to the 1997 Asian Crisis. Correlations across the markets increased dramatically during the economic crisis but only during a relatively short period around the crisis. After the crisis, the benefits of international diversification improved substantially but did not return to the levels existing before the crisis. We then examine whether the market reactions to the crisis can be explained by economic fundamentals. We find that virtually all of the variation in returns across markets can be explained by these factors. The reaction of markets to the Asian Crisis was rational.     

A Web Of Shocks: Crises Across Asian Real Estate Markets

The behaviour of real estate markets during the 1997–98 Financial crisis in Asian economies has received little attention despite the extensive research on other asset markets over this time. This paper examines the transmission of shocks across national real estate markets prior to and during the Asian crisis using a multivariate latent factor framework. The results reveal that diversification opportunities prior to the crisis are much reduced during the crisis. A comparison with regional equity markets shows that the transmission of shocks differs across the real estate and equity markets, providing evidence that investment in multiple asset classes provides some protection from large market downturns.     

An empirical study to identify shift contagion during the Asian crisis

The paper is an empirical study on contagion during the 1997–1998 Asian crisis. In line with Sander and Kleimeier [Sander, H., Kleimeier, S., 2003. Contagion and causality: an empirical investigation of four Asian crisis episodes. International Financial Markets, Institution and Money 13, 171–186], Granger causality among Asian economies on sovereign debt market is tested. Using a new measure of causality, we attempt to show the existence of shift contagion defined as significant differences in cross-markets links between tranquil and crisis periods. Firstly, non-existent links during the tranquil period play a key role during the crisis. Secondly, causality directions give evidence of the major influence of the South Korean crisis which seems to prevail on investors to reassess the whole region.     

Structural Changes in Volatility of Foreign Exchange Rates after theAsian Financial Crisis

Regime-shift models of daily returns are estimated for the foreign exchange rates of the Asian currencies that suffered from drastic devaluation during the Asian financial crisis in 1997, and the change points are detectedfor their volatility structures. Furthermore, how the persistence in the volatility of their exchange rates changed after the crisis is examined.     

Do controlling shareholders' expropriation incentives imply a link between corporate governance and firm value? Theory and evidence

We develop and test a model that investigates how controlling shareholders' expropriation incentives affect firm values during crisis and subsequent recovery periods. Consistent with the prediction of our model, we find that, during the 1997 Asian financial crisis, Asian firms with weaker corporate governance experience a larger drop in their share values but, during the post-crisis recovery period, such firms experience a larger rebound in their share values. We also find consistent evidence for Latin American firms during the 2001 Argentine economic crisis. Our results support the view that controlling shareholders' expropriation incentives imply a link between corporate governance and firm value.     

East Asia and Europe during the 1997 Asian collapse: a clinical study of a financial crisis

Asian stock markets are compared with European markets before and during the 1997 Asian crisis. The clinical issue is whether regional inter-dependence became larger around the crisis, fomenting investor fears of contagion and reducing asset values because of lower diversification potential. Statistical measures are developed to aid in this inquiry. We find that European and East Asian countries were not susceptible to volatility contagion in the pre-crisis era but that susceptibility increased significantly with the onset of the crisis. Covariances, correlations, and volatilities increased from the pre-crisis to the crisis period in both regions, but the percentage increases were much larger in Asia. Diversification potential was better in Asia than in Europe before the crisis; this was reversed during the crisis. The observed decline in diversification potency in Asia is reason enough for large declines in asset values though one cannot prove, of course, that it was the cause rather than the effect of the crisis. Exchange rate volatility played a major role.     

Are financial spillovers stable across regimes?: Evidence from the 1997 Asian crisis

We investigate breaks in financial spillovers between the US and eight South-East Asian capital markets before and during the 1997 Asian crisis. We construct threshold vector autoregressive models and apply novel techniques to test whether causality patterns between markets are characterized by one or two regimes. Linkages between the US and Asian markets are shown to follow the threshold model with two regimes, turmoil and tranquility, pointing to differences in cross-border return spillovers in stable and crisis periods. The causality analysis shows that spillovers between US and Asian markets become stronger in the turmoil regime.