The aim is to estimate a factor model ﬁtted to ﬁnancial returns to disentagle the role played by common shock and idiosincratic shocks in shapingthe comovement between asset returns during periods of calm and ﬁnancial turbulence. For this purpose, we use wavelet analysis and, in particular,the Maximum Overlapping Discrete Wavelet Transform, to decompose the covariance matrix of the asset returns on a scale by scale basis, whereeach scale is associated to a given frequency range. This decomposition will give enough moment conditions to identify the role played by commonand idiosincratic shocks. A Montecarlo simulation experiment shows that our testing methodology has good size and power properties to test forthe null of no contagion (that is, of absence of an increasing role of idiosincratic shocks during turmoil). Finally, using Full Information MaximumLikelihood, we ﬁt our model to test ﬁrst for the presence of contagion whithin the East Asian region stock msarkets during the 1997-1998 periodof ﬁnancial turbulence, and, then, whether there is contagion from an index of ﬁnancial distress in the US to East Asia during the recent sub-primecrisis.
|Number of pages||35|
|Publication status||Published - 2011|