Measuring financial contagion by local Gaussian correlation
Working paper

View/ Open
Date
2010-09Metadata
Show full item recordCollections
- Discussion papers (FOR) [575]
Abstract
This paper examines financial contagion, that is, whether the cross-market linkages
in financial markets increases after a shock to a country. We introduce the use of a
new measure of local dependence (introduced by Hufthammer and Tjøstheim (2009)) 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 proposed
bootstrap testing procedure. Examining the Mexican crisis of 1994, the Asian crisis
of 1997-1998 and the financial crisis of 2007-2009, we find some evidence of contagion
based on our new procedure.
Publisher
Norwegian School of Economics and Business Administration. Department of Finance and Management ScienceSeries
Discussion paper2010:12