Empirical Modelling of Contagion: A Review of Methodologies

Abstract

There is now a reasonably large body of empirical work testing for the existence of contagion during financial crises. A range of different methodologies are in use, making it difficult to assess the evidence for and against contagion, and particularly its significance in transmitting crises between countries. The origins of current empirical studies of contagion stem from Sharpe (1964) and Grubel and Fadner (1971), and more recently from King and Wadhwani (1990), Engle et al. (1990) and Bekaert and Hodrick (1992).k The aim of the present paper is to provide a unifying framework to highlight the key similarities and differences between the various approaches. For an overview of the literature see Dornbusch et al. (2000) and Pericoli and Sbracia (2003). The proposed framework is based on a latent factor structure which forms the basis of the models of Dungey and Martin (2001), Corsetti et al. (2001, 2003) and Bekaert et al. (2005). This framework is used to compare directly the correlation analysis approach popularized in this literature by Forbes and Rigobon (2002), the VAR approach of Favero and Giavazzi (2002), the probability model of Eichengreen et al. (1995, 1996) and the co-exceedance approach of Bae et al. (2003).