Detecting Financial Contagion in a Multivariate System Bertrand Candelon IPAG Business School Kent Business School - January 26th 2015 Vienna 11/20/20141.

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Presentation transcript:

Detecting Financial Contagion in a Multivariate System Bertrand Candelon IPAG Business School Kent Business School - January 26th 2015 Vienna 11/20/20141

Motivation – Financial Crises Sources of financial crises : - Fundamental based Crises (Flood and Garber, 1984) - Non Fundamental based Crises (Obstfeld, 1996) Self-fulfilling propheciesMoral Hazard Contagion Vienna 11/20/20142

Motivation – Contagion I Contagion Crisis originates in a particular country then it diffuses in other countries and disappear Inherited from the medical framework – The virus is transmitted from patients to patients then disappear Vienna 11/20/20143

Motivation – Contagion II Evaluating Contagion It requires : 1/ transmission channels 2/ stable transmission but difficult to obtain: So weak form - Shift-contagion Vienna 11/20/20144

Motivation – Contagion III Shift-Contagion Contagion – Temporary increase in the correlation (dependance) between 2 markets - King & Wadwhani Baig and Goldfajn 1999,… Bivariate system + Exogenous brake dates Vienna 11/20/20145

Motivation – Contagion IV Forbes and Rigobon (2002) Testing for increase in correlation is biased by an increase in volatility corr h > corr l simply because s x l <s x h So FR proposes a correction to conditional correlation where Vienna 11/20/20146

Motivation – Our Contribution Testing for shift-contagion taking into account for. Endogenous break-date. Multivariate set-up (third country effect). Test for distinctive breaks in variance and correlation How? Sequential Testing Procedure (STP) relying on Qu and Perron (QP) (2007) Vienna 11/20/20147

Sketch of the talk 2. Sequential testing Procedure (STP). The set-up. Procedure. Testing. Monte-Carlo Experiments 3. Empirical application (Asia 1997) Vienna 11/20/20148

STP – The Set-up I Stationnary n-dimentional VAR  Matrix var-cov, no normality assumption required only weak assumption (Theorems A4-A5 QP). Vienna 11/20/20149

STP – The Set-up II  is decomposed into variances an covariance terms (FR).. Interpretation of the contagion will be different if the breaks occur in variance or covariance terms at the same date/different date. More precise analysis for third country effect. Vienna 11/20/201410

STP – The Procedure I 1- Test for m distinct unknown variance breaks. 2- Test for n distinct unknown correlation breaks (using standardized residuals). 3- Test for the distinctiveness between variance and correlations breaks. Note that QP allow to run 1 and 2 simultaneously, but it is technically non tractable for m and m’ large. Vienna 11/20/201411

STP – Testing I Based on LR test as in QP. 1- hyp: log-lik and Vienna 11/20/201412

STP – Testing II 2- hyp: log-lik Vienna 11/20/201413

STP – Testing III (Perron-Oka, 2011) 3- Distinctivness (common break) Critical value are bootstrapped simulated as suggested in Perron-Oka (2011) Vienna 11/20/201414

STP – Monte-Carlo experiments I Vienna 11/20/201415

STP – Monte-Carlo experiments II Vienna 11/20/201416

STP – Monte-Carlo experiments III Vienna 11/20/201417

STP – Monte-Carlo experiments IV Vienna 11/20/201418

STP – Monte-Carlo experiments V Vienna 11/20/201419

STP – Monte-Carlo experiments VI Vienna 11/20/201420

Empirical – Case presentation I. 8 daily stock index returns.. 01/07/ /30/ Japan, Hong Kong, Thailand, Indonesia, Taiwan, Malaysia, Korea and the Philippines.. Underlying model : VARX(1,1) model with the U.S. stock index (t-1).. The confidence intervals have been determined by a block bootstrap of 1,000 repetitions with blocks of 20 days. Vienna 11/20/201421

Empirical – Case presentation II. Asian crisis – Thai Baht collapse July 2th, 1997, but markets were stressed before.. Second shock – Hong-Kong October. Objectives: More precise analysis of the contagion process during the Asian crisis using STP. Vienna 11/20/201422

Empirical – STP Vienna 11/20/201423

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Empirical – STP Vienna 11/20/201426

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Economic Analysis Break in variances are occuring before correlation ones. distinctiveness between variance and correlation breaks. Crucial in analysis the contagion process. Vienna 11/20/201434

Economic Analysis Analysis of contagion is important to understand financial crises. Endogenous break Multiviate approach is required Separate breaks in variance and in correlation Vienna 11/20/201435

Extension Analysis of contagion on European CDS markets. On going application for the revision of the paper…. Vienna 11/20/201436