Model of Financial Crisis Contagion: A Survey-Based Simulation Using Modified Kaplan-Meier Survival Plots

Abstract

Purpose: The current paper attempts to contribute to the vigorous debate about policies and regulations that would shield financial markets’ participants from future events of the financial turmoil. In doing so, the paper aims to broaden the picture of the financial crisis contagion and set it against the background of contemporary European markets. The main purpose of this paper is to present novel aspects of the financial crisis contagion, hence clarifying the contagion theory that still remains confusing and ambiguous for both the academics and financial market practitioners. This, however, requires a detailed overview of international financial linkages between markets, with particular attention paid to spot vulnerabilities in regulatory frameworks that allowed for the financial crisis contagion to spread. Henceforth, the current research paper attempts to address issues associated with the overconfidence of policy makers and financial supervisory authorities which believed that the financial crises affecting advanced markets would not be transferred to the emerging ones.This research paper is designed to deal with the notion of the international financial crisis contagion that still remains the least understood phenomenon confusing practitioners associated with financial markets worldwide. As spotted by Rigobon (2002), a lack of comprehensive knowledge of the ways financial crises spread throughout stock markets caused substantial investment losses. These losses were manly incurred by investors diversifying their portfolios with suboptimal choices. Therefore, a study that would shed light on the contagion processes across contemporary financial markets would be of great benefit to global investors. To this point, the current research paper focuses on the financial crisis contagion by adopting stock market practitioners’ perspectives. Moreover, the paper attempts to report findings that could contain useful advice for emerging markets’ authorities by suggesting an implementation of policies, stock market regulations, stimulus packages and fiscal plans that consider and manage the cross-market transfers of investment risks. This, however, does not suggest that markets lack regulations; rather this paper argues that the current policies are not effective in dealing with nascent problems concerning global capital flows. Addressing, these emergent problems require a more insightful analysis that would prevent from the occurrence of overregulation – e.g. taxation of capital flows as suggested decades ago by Tobin (1972), recently discussed within the structures of European Union. In addition, this paper acknowledges that the choice for macro-prudential supervisory systems should account for country-specific factors when dealing with the financial crisis contagion.Finally, the current paper aims to address the question whether financial crises can be predicted, especially in terms of their contagion across markets – this would provide implications of interest to international investors willing to diversify their portfolios with assets traded on European markets. This question remains open in academic circles and among practitioners associated with financial markets worldwide. To this point, the current research paper attempts to broaden the context of the financial crisis contagion to encompass the European markets that constitute international investment hubs attracting large numbers of practitioners. Especially important remains the focus on Central European emerging stock markets, as these investment hubs remain relatively under-researched.Design: The current paper builds on a simulation model for the financial crisis contagion that is rooted in the qualitative query and backed by semi-structured interviews with financial markets’ participants who possess extensive knowledge about the functioning of European markets and their interconnectedness. The methodology is rooted in the modified model of the Kaplan-Meier Survival Plots.With this in mind, the current paper adopts an international investor’s perspective on implications that stem from the linkages between European financial markets, flawed regulations and the absence of cross-border monitoring of the financial crisis contagion. By shifting its focus on Europe, this paper attempts to illustrate cross-market linkages between diverse groups of advanced and emerging markets. Such diversified research background enables the simulation model included to capture how propagation factors/links were being modified at different stages of the current financial contagion. Thus this paper strives to enrich the reviewed existing academic literature with novel and pioneering findings suggesting that the contagion factors/links are not constant over the period of transmission of the financial turmoil across European markets.Originality and Value: The current paper addresses the issues of the financial crisis contagion that belong to the group of the most commonly referenced yet least understood notions in finance. Furthermore, the paper focuses on addressing the recently exposed fragility of financial markets’ surveillance and regulations. In doing so, the paper employs a pioneering approach to a simulation of the financial crisis contagion by embarking on a qualitative query rather than empirical data. Henceforth, the limitations of the empirical simulations – experienced in the past studies devoted to investigation of the financial crisis contagion – were ameliorated and the findings presented in the paper became of practical use for the markets’ practitioners and policymakers.