A New Approach to Measuring Financial Contagion

This article proposes a new approach to evaluate contagion in financial markets. Our measure of contagion captures the coincidence of extreme return shocks across countries within a region and across regions. We characterize the extent of contagion, its economic significance, and its determinants using a multinomial logistic regression model. Applying our approach to daily returns of emerging markets during the 1990s, we find that contagion is predictable and depends on regional interest rates, exchange rate changes, and conditional stock return volatility. Evidence that contagion is stronger for extreme negative returns than for extreme positive returns is mixed. Since 1997, economists, policymakers, and journalists have talked about the ` ̀ Asian flu.' ' It has generally been perceived that the adverse currency and stock market shock that first affected Thailand in July 1997 propa-gated across the world with little regard for economic fundamentals in the affected countries. Before the Asian flu, there was the 1994 Mexican ``Tequila crisis,' ' and since then, the 1998 ``Russian virus.' ' Emerging markets economic crises, in general, have been characterized as contagious. According to Webster's dictionary, contagion is defined as ``a disease that can be communicated rapidly through direct or indirect contact.' ' Emerging markets economic crises have led to massive bailouts to quell contagion and have reduced support for free capital mobility