P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come FINANCIAL CONTAGION P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come The Robert W. Kolb Series in Finance provides a comprehensive view of the field of finance in all of its variety and complexity. The series is projected to include approximately 65 volumes covering all major topics and specializations in finance, ranging from investments, to corporate finance, to financial institutions. Each vol- ume in the Kolb Series in Finance consists of new articles especially written for the volume. Each volume is edited by a specialist in a particular area of finance, who devel- ops the volume outline and commissions articles by the world’s experts in that particular field of finance. Each volume includes an editor’s introduction and ap- proximately thirty articles to fully describe the current state of financial research and practice in a particular area of finance. The essays in each volume are intended for practicing finance professionals, grad- uate students, and advanced undergraduate students. The goal of each volume is to encapsulate the current state of knowledge in a particular area of finance so that the reader can quickly achieve a mastery of that special area of finance. Please visit www.wiley.com/go/kolbseries to learn about recent and forthcoming titles in the Kolb Series. P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come FINANCIAL CONTAGION The Viral Threat to the Wealth of Nations Editor Robert W. Kolb The Robert W. Kolb Series in Finance John Wiley & Sons, Inc. P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come Copyright c  2011 by John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Financial contagion : the viral threat to the wealth of nations / Robert W. Kolb, editor. p. cm. – (Robert W. Kolb series in finance) Includes bibliographical references and index. ISBN 978-0-470-92238-5 (hardback) 1. Financial crises. 2. International finance. 3. Financial risk management. I. Kolb, Robert W., 1949– HB3722.F528 2011 332  .042–dc22 2010043305 Printed in the United States of America 10987654321 P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come To the next generation, Katherine Ann Kolb and Rafael A. Quinn P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come Contents Introduction xiii Acknowledgments xv PART ONE Contagion: Theory and Identification 1 1WhatIsFinancial Contagion?3 Robert W. Kolb 2 Correlation Analysis of Financial Contagion 11 Giancarlo Corsetti, Marcello Pericoli, and Massimo Sbracia 3 Uncertainty and Contagion 21 Prakash Kannan and Fritzi Koehler-Geib 4 Contagion Dating through Market Interdependence Analysis and Correlation Stability 29 Monica Billio and Massimiliano Caporin 5 Contagion or Interdependence: Does the Speed of the Transmission of Shocks Matter? 37 Stefanie Kleimeier, Thorsten Lehnert, and Willem F. C. Verschoor 6 Modeling International Financial Markets Contagion: Using Copula and Risk Appetite 45 Sichong Chen and Ser-Huang Poon 7 The Origins and Resolution of Financial Crises: A Policy Dilemma 57 Lars Oxelheim, Clas Wihlborg, and Finn Østrup 8 Runs on Chartered and Shadow Banks: The Mechanics and Implications 67 Robert R. Bliss and George G. Kaufman vii P1: OTA/XYZ P2: ABC fm JWBT430-Kolb December 21, 2010 14:16 Printer Name: Yet to Come viii Contents 9 Debt and Currency Crises 75 Christian Bauer, Bernhard Herz, and Volker Karb 10 A Fixed-Time Effects Model of Contagion 87 Dirk G. Baur and Ren ´ ee A. Fry 11 Contagion or Interdependence in the Financial Markets of Asia, Latin America, and the United States: From Tequila Effect to the Subprime Crisis 93 Emerson Fernandes Marc¸al, Pedro L. Valls Pereira, Di ´ ogenes Manoel Leiva Martin, Wilson Toshiro Nakamura, and Wagner Oliveira Monteiro PART TWO Contagion and the Asian Financial Crisis 101 12 Dynamic Correlation Analysis of Financial Contagion: Evidence from Asian Markets 103 Thomas C. Chiang, Bang Nam Jeon, and Huimin Li 13 Contagion Effects, Informational Effects, and Economic Fundamentals: An Analysis of Exchange Rate Dynamics during the Asian Currency Crisis 115 Kam-hon Chu 14 Contagion and the Transmission of Financial Crises 129 Mardi Dungey, Ren ´ ee A. Fry, Brenda Gonz ´ alez-Hermosillo, Vance L. Martin, and Chrismin Tang 15 The Russian Financial Crisis, U.S. Financial Stock Returns, and the International Monetary Fund 137 M. Humayun Kabir and M. Kabir Hassan PART THREE Contagion and Emerging Markets 147 16 Measuring Bulls and Bears Synchronization in East Asian Stock Markets 149 Bertrand Candelon, Stefan Straetmans, and Jan Piplack 17 Linkages between Debt Markets in the United States and Emerging Economies 157 Guillermo Felices, Christian Grisse, and Jing Yang [...]... increase in the volatility of the returns r j Holding the parameters α1 and β1 constant, the effect of the crisis on the cross-country correlation of returns will depend on the extent to which the rise in the variance of r j is driven by the variance of the common factor f , as opposed to the variance of the country-specific factor ε j If movements in the common factors are relatively large, the correlation... consider the problem of contagion in a variety of concrete episodes, episodes that are the subject matter of many subsequent chapters: the Russian default of 1998, the Brazilian crisis of 1999, the dot-com crisis at the beginning of the twenty-first century, the long-lived Argentine crisis from 2001 to 2005, and, of course, the financial crisis of 2007–2009 T 1 P1: OTA/XYZ P2: ABC c01 JWBT430 -Kolb January... about the first asset was true This kind of potentially contagious event is referred to as a wake-up call The perception of a lower value for the first asset awakens investors to the true economic value of other assets It seems that part of the Asian financial crisis of the late 1990s stemmed from such a wake-up call when a realization that the Thai baht was overvalued led investors to question the value of. .. ABC c02 JWBT430 -Kolb December 21, 2010 14:17 Printer Name: Yet to Come CORRELATION ANALYSIS OF FINANCIAL CONTAGION 13 20 18 16 14 12 10 8 6 4 2 0 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Exhibit 2.1 Number of Countries Experiencing Stock Market Distress (Values, Weekly Data) Source: Elaborations on Thomson Reuters Datastream The figure shows the number of countries... (up to more than 40 percent for the cross-country median), affecting most countries, as shown by the small interquartile difference P1: OTA/XYZ P2: ABC c02 JWBT430 -Kolb December 21, 2010 14 14:17 Printer Name: Yet to Come Contagion: Theory and Identification 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Exhibit 2.2 Volatility of Stock... large shocks to a common factor, affecting all asset returns across the world Other things equal, a higher variance of the common factor simultaneously causes higher-than-usual volatility and stronger comovements in all markets In other words, holding the parameters of the data-generating process constant (other than the variance of the common factor), so that by definition there is no break in the international... respectively, the tranquil period (a regime characterized by the absence of crisis) and the crisis period (a regime of turmoil initiated by the crisis in country j) The correlation statistic φ depends on the correlation in the tranquil period (ρ), the change in the variance of r j during the crisis (δ), as well as the relative importance of the idiosyncratic factor relative to the global factor during the tranquil... thought Further, assume that this information becomes public Given the reduced value of the first asset, one may quickly come to view other similar assets as overpriced This can lead to a rapid reassessment of the value of these other assets In some sense, the financial difficulty in the first asset is transmitted to others through the medium of changed investor perceptions In this example, the information... same token, there was no rise in correlation before the P1: OTA/XYZ P2: ABC c02 JWBT430 -Kolb December 21, 2010 14:17 Printer Name: Yet to Come CORRELATION ANALYSIS OF FINANCIAL CONTAGION 15 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Exhibit 2.3 Covariances between Stock Market Returns (Annualized Values, Weekly Data)... which weekly returns on the stock market index recorded a decline of 20 percent or more with respect to the peak achieved over the previous year the associated collapse of the U.S hedge fund LTCM in 1998; the U.S recession in 2001 and the terrorist attacks on September 11; the period preceding the Second Gulf War; the Great Recession of 2008–2009 In the other three episodes, the financial turmoil was . in the Kolb Series. P1: OTA/XYZ P2: ABC fm JWBT430 -Kolb December 21, 2010 14:16 Printer Name: Yet to Come FINANCIAL CONTAGION The Viral Threat to the Wealth of Nations Editor Robert W. Kolb The. www.wiley.com. Library of Congress Cataloging-in-Publication Data: Financial contagion : the viral threat to the wealth of nations / Robert W. Kolb, editor. p. cm. – (Robert W. Kolb series in finance) Includes. variety of con- crete episodes, episodes that are the subject matter of many subsequent chapters: the Russian default of 1998, the Brazilian crisis of 1999, the dot-com crisis at the beginning of the