Are 1997 Asian Twin Crises Contagious?

Abstract

Until recently, currency and banking crises (twin crises) have been largely treated as separate phenomena, but the recent experiences of several Southeast Asian countries indicate that both banking and currency crises can occur jointly. However, most of empirical literature has focused on the determinants of each type of crisis in isolation and little empirical work to date has systematically investigated the association of the twin crises. In particular, no study has tested if the is a pure contagion effect between the twin crises. This paper tries to fill this gap by examining the pure contagion effect both within a country and across countries using data from Japan and Thailand. The empirical results indicate that within a country there is a positive feedback relation between Thai banking sector and its currency market, indicating a within country bi-directional contagion-in-mean effect between the twin crises. Across countries there are unidirectional relations between Thai banking sector and Japanese currency market and between Japanese banking sector and Thai currency market, suggesting a unidirectional cross-country contagion-in-mean effect between the twin crises. As for contagion-in-volatility, it is not significant, implying that there is no incremental increase in volatility during the 1997 Asian crisis. Finally, the global banking industry risk is significantly priced.