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Correlation Coefficients, Heteroskedasticity And Contagion Of Financial Crises

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  • GAWON YOON

Abstract

A significant increase in the correlation coefficients of returns across countries during periods of high turbulence is regarded as evidence of the contagion of financial crises. However, heteroskedasticity is known to cause correlation coefficients to be biased upward. This note shows that correlation coefficients can be biased downward under heteroskedasticity when returns are following stochastic unit root processes. Further, returns are known to be nonlinear, so correlation coefficients might not be very useful in measuring relations between them. These results indicate that the time‐series behavior of returns needs to be more thoroughly studied prior to measuring the contagion of financial crises with correlation coefficients.

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  • Gawon Yoon, 2005. "Correlation Coefficients, Heteroskedasticity And Contagion Of Financial Crises," Manchester School, University of Manchester, vol. 73(1), pages 92-100, January.
    • Handle: RePEc:bla:manchs:v:73:y:2005:i:1:p:92-100
    DOI: 10.1111/j.1467-9957.2005.00426.x
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    2. Bunda, Irina & Hamann, A. Javier & Lall, Subir, 2009. "Correlations in emerging market bonds: The role of local and global factors," Emerging Markets Review, Elsevier, vol. 10(2), pages 67-96, June.
    3. Irina Bunda & A. Javier Hamann & Subir Lall, 2007. "Emerging Debt Markets: What Do Correlations and Spreads Tell Us?," Post-Print halshs-00424468, HAL.
    4. Essahbi Essaadi & Jamel Jouini & Wajih Khallouli, 2009. "The Asian Crisis Contagion: A Dynamic Correlation Approach Analysis," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(2), pages 241-260, June.
    5. Wajih Khallouli, 2008. "Shift-Contagion in Middle East and North Africa Stock Markets," Working Papers 420, Economic Research Forum, revised 06 Jan 2008.

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