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Unobservable shocks as carriers of contagion
journal contributionposted on 2023-05-17, 04:52 authored by Dungey, M, Milunovich, G, Thorp, S
We propose an identified structural GARCH model to disentangle the dynamics of financial market crises. We distinguish between the hypersensitivity of a domestic market in crisis to news from foreign non-crisis markets, and the contagion imported to a tranquil domestic market from foreign crises. The model also enables us to connect unobserved structural shocks with their source markets using variance decompositions and to compare the size and dynamics of impulses during crises periods with tranquil period impulses. To illustrate, we apply the method to data from the 1997–1998 Asian financial crisis which consists of a complicated set of interacting crises. We find significant hypersensitivity and contagion between these markets but also show that links may strengthen or weaken. Impulse response functions for an equally-weighted equity portfolio show the increasing dominance of Korean and Hong Kong shocks during the crises and covariance responses demonstrate multiple layers of contagion effects.
Publication titleJournal of Banking and Finance
PublisherElsevier Science Bv
Place of publicationPo Box 211, Amsterdam, Netherlands, 1000 Ae
Rights statementThe definitive version is available at http://www.sciencedirect.com