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Regionality revisited: an examination of the direction of spread of currency crises

Dasgupta, Amil and Leon-Gonzalez, Roberto and Shortland, Anja (2006) Regionality revisited: an examination of the direction of spread of currency crises. Discussion paper, 584. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Identification Number: 584

Abstract

What determines the direction of spread of currency crises? We examine data on waves of currency crises in 1992, 1994, 1997, and 1998 to evaluate several hypotheses on the determinants of contagion. We simultaneously consider trade competition, financial links, and institutional similarity to the “ground-zero” country as potential drivers of contagion. To overcome data limitations and account for model uncertainty, we utilize Bayesian methodologies hitherto unused in the empirical literature on contagion. In particular, we use the Bayesian averaging of binary models which allows us to take into account the uncertainty regarding the appropriate set of regressors. We find that institutional similarity to the ground-zero country, as measured by quality-of-governance indicators, plays an important role in determining the direction of contagion in all the emerging market currency crises in our dataset. We thus provide persuasive evidence in favor of the “wake up call” hypothesis for financial contagion. Trade and financial links may also play a role in determining the direction of contagion, but their importance varies amongst the crisis periods and may be sensitive to the specification of the prior.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2006 The Authors
Subjects: H Social Sciences > HB Economic Theory
JEL classification: F - International Economics > F3 - International Finance > F31 - Foreign Exchange
F - International Economics > F3 - International Finance > F32 - Current Account Adjustment; Short-Term Capital Movements
C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods: General > C11 - Bayesian Analysis
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Date Deposited: 29 Jul 2009 10:08
Last Modified: 27 Feb 2014 15:35
URI: http://eprints.lse.ac.uk/id/eprint/24636

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