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Measuring Financial Contagion by Local Gaussian Correlation

Author

Listed:
  • Støve, Bård

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

  • Tjøstheim, Dag

    (Dept. of Mathematics, University of Bergen)

  • Hufthammer, Karl Ove

    (Dept. of Mathematics, University of Bergen)

Abstract

This paper examines financial contagion, that is, whether the cross-market linkages in financial markets increases after a shock to a country. We introduce the use of a new measure of local dependence (introduced by Hufthammer and Tjøstheim (2009)) to study the contagion effect. The central idea of the new approach is to approximate an arbitrary bivariate return distribution by a family of Gaussian bivariate distributions. At each point of the return distribution there is a Gaussian distribution that gives a good approximation at that point. The correlation of the approximating Gaussian distribution is taken as the local correlation in that neighbourhood. By examining the local Gaussian correlation before the shock (in a stable period) and after the shock (in the crisis period), we are able to test whether contagion has occurred by a proposed bootstrap testing procedure. Examining the Mexican crisis of 1994, the Asian crisis of 1997-1998 and the financial crisis of 2007-2009, we find some evidence of contagion based on our new procedure.

Suggested Citation

  • Støve, Bård & Tjøstheim, Dag & Hufthammer, Karl Ove, 2010. "Measuring Financial Contagion by Local Gaussian Correlation," Discussion Papers 2010/12, Norwegian School of Economics, Department of Business and Management Science.
  • Handle: RePEc:hhs:nhhfms:2010_012
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    File URL: http://hdl.handle.net/11250/164142
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial Contagion; Crisis; Gaussian Correlation;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General

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