Contagion in the Brazilian interbank currency exchange market: an empirical analysis

Abstract

The risk of contagion is the possibility that the failure of a financial institution affected by an exogenous shock generates the failure of other institutions not initially affected by the shock. As pointed out by Upper and Worms (2002) and others, the domino effect in the payment system depends on the precise pattern of interbank linkages. This paper studies the occurrence of financial contagion after the exogenous failure of an institution authorized to operate in the Brazilian interbank currency market. The data contain information about all the actual transactions that occurred in this market from August 1st, 2000 to October 31st, 2002. The adopted methodology shows the occurrence of contagion propagation in several subsequent rounds after the initial failure. We quantify the number of institutions that breakdown and the financial losses of the market. There is a large increase in the number of failed institutions during the period of the presidential elections in 2002.