Testing Financial Contagion with Time-Varying Correlation of Heteroscedastic Asset Returns

남기석

Abstract

We suggest that there is a significant time-varying relationship between cross-market co-movements and predictable market volatility. We demonstrate that the time-varying component of cross-market correlation is attributable to the responses by rational risk-averse investors who systematically revise their expectations in response to changing market volatility. Our results from the time-varying conditional correlation test for contagion show that (a) only the Philippines or the Philippines and Italy show evidence of contagion from the 1997 Asian crisis, and (b) there is no contagion evidence from both the 1994 Mexican peso crisis and 1987 U.S. stock market crash.