East Asian Financial Contagion under DCC-Garch

J H Cho,Ali M Parhizgari

doi:10.32890/ijbf2009.6.1.8380

Abstract

We consider the definition and measurement of contagion by analysing the 1997 East Asian financial crisis in the equity markets of eight countries using dynamic conditional correlation (DCC). Taking Thailand and Hong Kong as alternative sources of contagion, a total of fourteen source-target pairs is analyzed. We define contagion as the statistical break in the computed DCCs as measured by the shifts in their means and medians. In the DCC process, the parameters of each pair of source-target country contagion are allowed to vary and be dictated by the data. Contagion is tested using DCC means and medians difference tests. Our findings indicate the presence of contagion in the equity markets across all the fourteen pairs of source-target countries that are considered.

Highlights

Defining an evolutionary process in the context of cross-country analyses, the term contagion has gone through a gradual refinement and measurement process only in the last two decades or so
Unlike the volatilityadjusted cross-market correlations employed in Forbes and Rigobon (2002), dynamic correlation coefficients (DCC)-GARCH continuously adjusts the correlation for the time-varying volatility
We have provided a set of uniform results that suggest, overwhelmingly, contagion in the 1997 Asian equity markets

Summary

Introduction

Defining an evolutionary process in the context of cross-country analyses, the term contagion has gone through a gradual refinement and measurement process only in the last two decades or so. A simple (static) measure of correlation, for instance, between the stock return series of two countries, was deemed informative enough to establish the relation between their respective equity markets, and thereby aid in decisions on cross-country portfolio diversification. 2002) and that such estimates should consider the dynamic, i.e., the time-varying, aspect of correlations (Engle, 2002) This latter feature may be exploited in identifying and measuring contagion among cross-country markets. Though we employ DCC, our approach is somewhat different from theirs They assume the same parameters for each pair of contagion source and target countries in the correlation process while we do let the parameters to differ across pairs of countries.

Prior literature

Methodology

Empirical application

Summary and Conclusions