Unobservable shocks as carriers of contagion |
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Authors: | Mardi Dungey George Milunovich Susan Thorp |
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Institution: | 1. School of Economics and Finance, University of Tasmania, Private Bag 85, Hobart, Tasmania 7001, Australia;2. CFAP, University of Cambridge, Trumpington Street, Cambridge CB2 1AG, United Kingdom;3. Department of Economics, Macquarie University, NSW 2109, Australia;4. School of Finance and Economics, University of Technology, Sydney, PO Box 123, Broadway, NSW 2007, Australia |
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Abstract: | We propose an identified structural GARCH model to disentangle the dynamics of financial market crises. We distinguish between the hypersensitivity of a domestic market in crisis to news from foreign non-crisis markets, and the contagion imported to a tranquil domestic market from foreign crises. The model also enables us to connect unobserved structural shocks with their source markets using variance decompositions and to compare the size and dynamics of impulses during crises periods with tranquil period impulses. To illustrate, we apply the method to data from the 1997–1998 Asian financial crisis which consists of a complicated set of interacting crises. We find significant hypersensitivity and contagion between these markets but also show that links may strengthen or weaken. Impulse response functions for an equally-weighted equity portfolio show the increasing dominance of Korean and Hong Kong shocks during the crises and covariance responses demonstrate multiple layers of contagion effects. |
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Keywords: | G01 C51 |
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