Essays on financial contagion in emerging market economies

Cominetta, Matteo (2011) Essays on financial contagion in emerging market economies. Doctoral thesis (DPhil), University of Sussex.

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Abstract

Since the collapse of the Bretton Woods system the integration of national
financial markets grew steadily, to reach unprecedented levels. At the same time,
episodes of extreme financial instability became more frequent. The latter were often
extremely contagious, in the sense that country-specific episodes had hugely
disruptive effects on financial markets across the globe. The literature on Financial
Contagion investigates the channels through which that instability is propagated. This
thesis deals with the two most recurring questions in the literature:
1) What are the channels of macroeconomic instability propagation?
A theoretical model of instability propagation in presence of currency mismatches
is presented. The model shows that when domestic agents’ liabilities are denominated
in foreign currency, exchange rate volatility raises credit costs, with negative real
effects. Currency mismatches therefore create a channel through which external
disturbances causing exchange rate volatility affect negatively the domestic supply.
Several reasons why currency mismatches might magnify the effect of foreign
disturbances have been identified by the theoretical literature on the issue. The
empirical relevance of the magnification hypothesis is tested by investigating whether
the degree of domestic output’s sensitivity to foreign output fluctuations is higher in
countries where currency mismatches are widespread than in countries able to borrow
abroad in domestic currency. The analysis gives strong support to the hypothesis:
currency mismatches magnify the real effects of foreign disturbances. The analysis
also highlights the presence of asymmetry of propagation: negative shocks have
proportionally stronger real effects than positive ones in currency-mismatches-prone
countries.
2) Is the financial shocks propagation mechanism altered by major events such as
banking or currency crises?
The intensity of propagation of the crises in the ‘90s led researchers to ask whether
the linkages between countries grew stronger during these turbulent times or were
instead as strong before. Various tests of the instability of the propagation mechanism
have been proposed since. These can be divided in two families: correlation-based
and extreme-event-based tests. I propose a new approach, based on the Quantile
Regression technique. It is argued that this approach retains the appealing features of
the two families of test while avoiding some of their limitations. The new approach is
then applied to stock market returns, finding strong evidence of instability of the
propagation mechanism.

Item Type: Thesis (Doctoral)
Schools and Departments: School of Business, Management and Economics > Economics
Subjects: H Social Sciences > HB Economic theory. Demography
H Social Sciences > HG Finance
Depositing User: Library Cataloguing
Date Deposited: 20 Jun 2011 09:21
Last Modified: 17 Aug 2015 13:12
URI: http://sro.sussex.ac.uk/id/eprint/6971

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