Financial Market Contagion in the Asian Crisis

Taimur Baig, Ilan Goldfajn
1998 IMF Working Papers  
This paper tests for evidence of contagion between the financial markets of Thailand, Malaysia, Indonesia, Korea, and the Philippines. Cross-country correlations among currencies and sovereign spreads are found to increase significantly during the crisis period, whereas the equity market correlations offer mixed evidence. A set of dummy variables using daily news is constructed to capture the impact of own-country and cross-border news on the markets. After controlling for own-country news and
more » ... ther fundamentals, the paper shows evidence of cross-border contagion in the currency and equity markets. JEL Classification Numbers: F30, F40, G15 SUMMARY This paper tests for evidence of contagion in the exchange rates, interest rates, equity, and sovereign debt markets of Thailand, Malaysia, Indonesia, Korea, and the Philippines. A case for contagion is made when the correlations among the markets increase significantly during the crises as compared with tranquil levels. The sovereign spreads show clear evidence of contagion in each of the pairwise relationships tested. The results show a high degree of correlation and contagion between the markets of Indonesia and Malaysia (except the domestic interest rate market). Some of the equity markets in the region (e.g., Malaysia-Thailand and Philippines-Indonesia), despite displaying high degrees of correlation during the crises, were not significantly more correlated than in tranquil times. The correlations among sovereign spreads are extremely high, indicating a near simultaneous deterioration in the perceived default risk associated with the five countries. The paper also uses a set of dummy variables to capture the impact of own-country and cross-border news on the markets. The results show that even after controlling for owncountry news and other fundamentals, there is some evidence of cross-border contagion in the currency markets. The regression analysis involving all the country dummies shows that the currency markets in Thailand, Malaysia, the Philippines, and Korea were significantly affected by bad news originating from Indonesia.
doi:10.5089/9781451857283.001 fatcat:qrbzqx6rrfgydj7unj2ilgwobe