Evidence for financial contagion in endogenous volatile periods

Abstract

The objective of this study is to analyze cross-border contagious dynamics in both foreign exchange markets and stock exchange markets. Propagation is analyzed with respect to the transmission of excessive volatility that is endogenously determined. The contagion process is discussed in the context of financial systems, foreign direct investments and trade. Implementing a vector autoregressive-multivariate generalized autoregressive conditional heteroskedasticity (VAR-MGARCH) model, we show that country-specific turbulence in financial markets is able to create unanticipated financial contagion across countries. Diversified trade and financial relations decrease the risk of exposure to contagion from external markets. The world's largest economies, however, play a price-setter role, and diversification is of secondary importance. Asymmetric transmission of the empirically predicted contagion prevails in the latter case.